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2004

CHINA AS AN EMERGING REGIONAL AND 

TECHNOLOGY POWER: IMPLICATIONS FOR U.S. 

ECONOMIC AND SECURITY INTERESTS 

HEARING 

BEFORE THE

U.S.-CHINA ECONOMIC AND SECURITY 

REVIEW COMMISSION 

ONE HUNDRED EIGHTH CONGRESS 

SECOND SESSION 

FEBRUARY 12–13, 2004 

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 

PATRICK A. MULLOY, Commissioner 

WILLIAM A. REINSCH, Commissioner 

MICHAEL R. WESSEL, Commissioner 

LARRY M. WORTZEL, Commissioner 

DAVID J. OHRENSTEIN, Executive Director 

ROBERT A. BEAN, Senior Advisor and Director Public and Governmental Affairs 

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 216. 

(II) 

iii 

U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION

APRIL 6, 2004 

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 of Representatives, 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 San Diego, CA field hearing on February 12 

and 13, 2004 examining ‘‘China as an Emerging Regional and Technological Power: 

Implications for U.S. Economic and Security Interests.’’ China’s technology development, and the pivotal role it plays in the global supply chain for high-tech goods 

and services, has important implications for U.S. economic and security interests. 

The Commission is mandated (P.L. 108–7) to assess the qualitative and quantitative nature of the shift of United States production activities to China, including 

the relocation of high-technology, manufacturing and research and development facilities. Additionally the Commission is directed to examine China’s performance in 

protecting intellectual property rights, a key area of concern in U.S.-China high-tech 

trade. 

During this field hearing, held on the campus of the University of California, San 

Diego, the Commission heard testimony from a number of scholars and representatives of California’s technology industry. During the discussion, panelists highlighted several important themes: 

China’s High-Tech Development. The Chinese government has a coordinated, sustainable vision for science and technology development. Many Chinese high-technology developments have been spurred by policies the Chinese government has instituted to accelerate the growth of industries in this sector, which the government 

believes can help lift the whole economy. 

The Chinese government uses foreign investment, technology standards, and industry regulation to catalyze the nation’s technological growth. Government procurement remains a lever for technology policy, as do proprietary technology standards. If foreign companies adopt Chinese promulgated standards to get access to the 

growing Chinese market, they help build economies of scale, which then encourages 

the growth of exports out of China with these new standards. An example of this 

is China’s new wireless LAN standard. The Chinese government also uses its power 

over state corporations, and over companies that require licenses to produce or provide services, to organize bargaining cartels with foreign corporations to encourage 

technology transfers into China. 

Several hearing panelists noted the importance of China’s high-tech development 

to U.S. computer and electronics firms who are using it as a production base. One 

panelist noted that American computer and electronics firms had a rate of return 

in China of over 20 percent in 2002. Such profits encourage them to go along with 

Chinese ground rules for technology transfer. China is already the second largest 

computer manufacturer in the world, and it is expected that higher valued jobs in 

design, development and engineering will follow manufacturing to China. 

China is also making strides in the advanced fields of pharmaceutical and biotechnology production. Products manufactured by China’s pharmaceutical companies 

have to date principally been generic, but foreign investment and the transfers of 

technology and management systems that accompany this investment are accelerating the growth of a more sophisticated pharmaceutical industry. Foreign manufacturers of pharmaceuticals are beginning to establish R&D facilities in China. The 

biotech industry in China is also growing. According to one hearing panelist from 

the U.S. biotech industry, the Chinese government is supporting its development 

through the annual investment of over $600 million into universities, research centers, and labs. The Chinese government is encouraging Chinese nationals who have 

obtained Ph.D.’s in the life sciences field in the United States to return to China 

and is offering them incentives to do so. 

China’s Role in the Global Supply Chain. Global production networks dominate 

China’s high-tech export environment. Foreign investment into China has provided 

capital, management and technology to Chinese production in various technology 

sectors. Taiwan firms are key investors and intermediaries in China’s high-tech production networks. 

iv 

Maintaining the U.S. Technological Edge. The U.S. role in global high-tech production chains is in the more skill and technology intensive activities, particularly 

in the R&D stage of production. American-developed technology advances and innovation has generally maintained the United States’ status as a global economic leader. The Commission heard testimony from almost every panelist concerning the 

need for the United States to reinvest in its long-term human capital in order to 

maintain this technological edge. China currently graduates three times as many 

engineers as the United States at the bachelor’s degree level. There is a great need 

for the U.S. Government to explore policies aimed at expanding educational opportunities in the mathematics and sciences fields, and for upgrading the U.S. technology 

infrastructure. 

China’s Regional Outreach. China has become more receptive toward working in 

a multilateral format, particularly groupings in which it can exercise a leadership 

role—such as the Asia Pacific Economic Cooperation (APEC) and the Shanghai Cooperation Organization (SCO). Moreover, China’s growing economic influence in the 

region has enhanced its political leverage as well. This poses a challenge to ensure 

the United States is not excluded from the Asian region’s economic and security forums and that China’s role in these forums does not compromise U.S. goals in the 

region. 

China’s emergence as a center for high-tech manufacturing and R&D is one of the 

most significant dynamics of China’s economic growth and an area the Commission 

will continue to follow closely as it poses significant economic and security challenges for the United States. 

Yours truly, 

Roger W. Robinson, Jr. 

Chairman 

C. Richard D’Amato 

Vice Chairman 


Insert names.eps
(V) 

CONTENTS 

Page 

THURSDAY, FEBRUARY 12, 2004 

CHINA AND THE WTO: COMPLIANCE AND MONITORING 

Opening remarks of Chairman Roger W. Robinson, Jr. ....................................... 1, 97 

Opening statement ........................................................................................... 2 

Opening remarks of Commissioner Robert F. Ellsworth, Hearing Co-Chair .....5, 133 

Opening statement ........................................................................................... 7 

Opening remarks of Vice Chairman C. Richard D’Amato .................................... 3, 61 

Opening statement ........................................................................................... 4 

INTRODUCTION: CHINA AS AN EMERGING HIGH TECH GIANT

Statement of Dean Peter Cowhey, Graduate School of International Relations 

and Pacific Studies, University of California, San Diego, Director of Institute on Global Conflict and Cooperation ............................................................ 9 

PANEL I: THE CHINESE ECONOMY: CURRENT TRENDS AND FUTURE CHALLENGES

Statement of Barry Naughton, Ph.D., Professor of Economics, Graduate 

School of International Relations and Pacific Studies, University of California, San Diego .................................................................................................. 19 

Prepared statement .......................................................................................... 22 

Statement of K. C. Fung, Ph.D., Professor of Economics, University of California, Santa Cruz ................................................................................................ 27 

Prepared statement .......................................................................................... 30 

Statement of Scott Rozelle, Ph.D., Professor of Economic, Department of 

Agricultural and Resource Economics, University of California, Davis .......... 36 

Prepared statement .......................................................................................... 39 

Panel I: Discussion, Questions and Answers ........................................................ 50 

PANEL II: CHINA’S TRADE AND INVESTMENT WITH ITS NEIGHBORS

Statement of Richard Feinberg, Ph.D., Professor of Economics, Graduate 

School of International Relations and Pacific Studies, University of California, San Diego .................................................................................................. 61 

Prepared statement .......................................................................................... 64 

Statement of Stephan Haggard, Ph.D., Professor of Political Science and 

Director of Korea-Pacific Program, Graduate School of International Relations and Pacific Studies, University of California, San Diego ........................ 61 

Prepared statement .......................................................................................... 63 

Statement of Gordon Hanson, Ph.D., Professor of Economics, Graduate School 

of International Relations and Pacific Studies, University of California, 

San Diego .............................................................................................................. 70 

Prepared statement .......................................................................................... 73 

Panel II: Discussion, Questions and Answers ....................................................... 83 

AFTERNOON SESSION

PANEL III: BIOTECHNOLOGY

Statement of Dr. Lee Zhong, MD, Ph.D., President, Elene Pharmaceutical 

Co ........................................................................................................................... 98 

Prepared statement .......................................................................................... 100 

Statement of Kerry Dance, Ph.D., Managing Partner, Hamilton Apex Technology Ventures, LP ............................................................................................. 105 

Page

VI 

Statement of Kerry Dance, Ph.D., Managing Partner, Hamilton Apex Technology Ventures, LP—Continued 

Prepared statement .......................................................................................... 108 

Statement of Joseph Panetta, President/CEO, BIOCOM ..................................... 116 

Statement of Greg Lucier, President/CEO, Invitrogen Corp ................................ 118 

Prepared statement .......................................................................................... 119 

Panel III: Discussion, Questions and Answers ...................................................... 126 

PANEL IV: CHINA AS A HIGH-TECH LEADER: TECHNOLOGICAL CAPABILITIES: INTELLECTUAL PROPERTY PROTECTION AND MARKET ACCESS AND CHINESE OVERSEAS

INVESTMENT

Statement of William Bold, Vice President, Government Affairs, 

QUALCOMM, Inc. (Telecommunications) .......................................................... 134 

Statement of Jason Dedrick, Center for Research on Information Technology 

and Organization, University of California, Irvine (Electronics Manufacturing) ................................................................................................................... 137 

Statement of Francine Berman, Ph.D., Director, Super Computer Center, 

University of California, San Diego .................................................................... 139 

Prepared statement .......................................................................................... 142 

Statement of Michael May, Ph.D., Professor Emeritus, Center for International Security and Arms Control, Stanford University (Energy) ............... 146 

Prepared statement .......................................................................................... 150 

Panel IV: Discussion, Questions and Answers ...................................................... 153 

Open Microphone for Public Comment .................................................................. 163 

FRIDAY, FEBRUARY 13, 2004 

Opening remarks of Chairman Roger W. Robinson, Jr. ....................................... 166 

PANEL I: CHINA’S ROLE IN ASIA

Statement of Susan Shirk, Ph.D., Professor of Politcal Science, Graduate 

School of International Relations and Pacific Studies, University of California, San Diego .................................................................................................. 166 

Prepared statement .......................................................................................... 168 

Statement of Ellis Krauss, Ph.D., Professor of Political Science, Graduate 

School of International Relations and Pacific Studies, University of California, San Diego .................................................................................................. 173 

Prepared statement .......................................................................................... 1176 

Statement of David M. Lampton, Ph.D., Professor of Chinese and East Asian 

Studies, School of Advanced International Studies, Johns Hopkins University ......................................................................................................................... 184 

Prepared statement .......................................................................................... 188 

Panel I: Discussion, Questions and Answers ........................................................ 190 

(1) 

CHINA AS AN EMERGING REGIONAL AND 

TECHNOLOGY POWER: IMPLICATIONS FOR 

U.S. ECONOMIC AND SECURITY INTERESTS 

THURSDAY, FEBRUARY 12, 2004 

U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION

Washington, D.C. 

The Commission met in the Great Hall—International House at 

the University of California at San Diego at 9:00 a.m., Commissioners C. Richard D’Amato and Robert F. Ellsworth, Co-Chairs, 

presiding. 

OPENING REMARKS OF CHAIRMAN ROGER W. ROBINSON, JR. 

Chairman ROBINSON. If we might begin our session. 

Well, first, good morning. On behalf of the U.S.-China Economic 

Security Review Commission, I would like to welcome you to our 

two-day hearing here at the University of California, San Diego. 

Our Commission, the U.S.-China Economic and Security Review 

Commission, was established by the U.S. Congress to investigate 

the national security implications of our trade and economic relationship with China. 

The members of the Commission were appointed by Republican 

and Democratic leaders of both the U.S. Senate and House of Representatives. In setting out our mandate, the Congress directed us 

to take a broad view of national security to include an assessment 

of how our economic relationship with China is impacting U.S. economic and security interests. This is the Commission’s second field 

investigation outside of Washington, D.C. Our first was on January 

30th in Columbia, South Carolina, where we examined the impact 

of trade with China on the U.S. manufacturing base. We heard 

powerful, personal perspectives on this issue from representatives 

of South Carolina’s industries, workers and communities that are 

experiencing significant economic dislocations—indeed, a crisis—in 

the face of China’s rapid manufacturing growth, particularly in textiles, apparel and steel. The Commission has traveled to Southern 

California to hear views on China’s capabilities in the production 

and development of high-technology goods and services, particularly in the areas of biotechnology, nanotechnology, telecommunications, energy, computing and information technology. These industries pose a very different array of economic and security challenges from those highlighted in our South Carolina experience. 

The goal of our field investigation is to examine closely the 

changing trade and investment patterns in the East Asian region 

due to China’s robust economic growth. 

2 

Crucial to this issue is China’s emergence as a major player in 

the production of high-tech goods and services and its increasing 

involvement in advanced research and development in many fields. 

Assessing the implications of these developments for both U.S. 

economic and national security interests is at the heart of the Commission’s mandate. 

Our two-day hearing in Southern California was organized by my 

colleague Ambassador Robert Ellsworth, and I would like to thank 

him on behalf of the Commission for developing such an important 

and timely event. I would also like to extend the Commission’s appreciation to someone we’ll hear from very shortly, Dean Cowhey, 

Professor Shirk and all the others at the Graduate School of International Relations and Pacific Studies who worked so hard to make 

this on-site visit possible. 

Through your good work we have assembled an impressive and 

distinguished gathering of experts to help facilitate our understanding of an important component of China’s economic development and U.S.-China relations. I would also invite the participants 

in our audience to visit our Web site at www.uscc.gov for more information on the broad-based work of the Commission. 

I would now like to turn over the proceedings to the vice chairman of our Commission, Dick D’Amato. And then he, in turn, will 

be passing the baton to Ambassador Ellsworth, who will be the Cochair of today’s hearing. Thank you. 

[The statement follows:] 

Opening Statement by Chairman Roger W. Robinson, Jr. 

First, good Morning. On behalf of the U.S.-China Economic and Security Review 

Commission, I would like to welcome you to our two-day hearing here at the University of California, San Diego. 

Our Commission was established by the U.S. Congress to investigate the national 

security implications of our trade and economic relationship with China. The members of the Commission were appointed by the Republican and Democratic leaders 

of both the U.S. Senate and House of Representatives. In setting out our mandate, 

the Congress directed us to take a broad view of national security to include an assessment of how our economic relationship with China is impacting U.S. economic 

and security interests. 

This is the Commission’s second field investigation outside of Washington, DC. 

Our first was on January 30th in Columbia, South Carolina where we examined the 

impact of trade with China on the U.S. manufacturing base. We heard powerful, 

personal perspectives on this issue from representatives of South Carolina industries, workers and communities that are experiencing significant economic dislocations—indeed, a crisis—in the face of China’s rapid manufacturing growth, particularly in textiles, apparel, and steel. 

The Commission has traveled to Southern California to hear views on China’s capabilities in the production and development of high-tech goods and services—particularly in the area of biotechnology, nanotechnology, telecommunications, energy, 

computing, and information technology. These industries pose a different array of 

economic and security challenges from those highlighted in South Carolina. 

The goal of our field investigation is to examine closely the changing trade and 

investment patterns in the East Asian region due to China’s economic growth. Crucial to this issue is China’s emergence as a major player in the production of hightech goods and services and its increasing involvement in advanced research and development in many fields. Assessing the implications of these developments—for 

both U.S. economic and national security interests—is at the heart of the Commission’s mandate. 

Our two-day hearing in Southern California was organized by my colleague Ambassador Robert Ellsworth, and I’d like to thank him on behalf of the Commission 

for developing such an important and timely event. I would also like to extend the 

Commission’s appreciation to Dean Cowhey, as well as Professor Shirk, and all the 

others at the Graduate School of International Relations/Pacific Studies who worked 

3 

so hard to make this on-site visit possible. Through your good work we have assembled an impressive and distinguished gathering of experts to help facilitate our understanding of an important component of China’s economic development and U.S.- 

China relations. I would also invite the participants and our audience to visit our 

website at www.uscc.gov for more information on the work of the Commission. 

I will now turn over the proceedings to our Vice Chairman, Dick D’Amato, and 

Ambassador Robert Ellsworth, who will co-chair today’s hearing. 

OPENING REMARKS OF VICE CHAIRMAN C. RICHARD D’AMATO 

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

I join Chairman Robinson in thanking Ambassador Ellsworth for 

focusing the Commission’s attention on the important topic before 

us and on the unique perspective offered on these issues by the 

California university community and high-technology community. I 

would also like to personally commend Dean Peter Cowhey, Professor Susan Shirk and their staff and faculty of the Graduate 

School of International Relations/Pacific Studies for their outstanding effort in helping develop this two-day event. 

As the chairman mentioned, we were recently as a Commission 

in Columbia, South Carolina, ten days ago or so, investigating the 

impact of outsourcing and offshoring the U.S. manufacturing base. 

The story is devastating there, alarming and rapidly escalating in 

industries like textiles, furniture and steel. Action in the Congress 

to attempt to manage this is all but inevitable in the near future. 

But there is more to the offshoring story than manufacturing and 

basic manufacturing, as the people of California know. In corporations’ relentless search for lower costs and favorable quarterly 

earnings reports, high-tech and I.T. services are moving with increasing rapidity and frequency to India, China and elsewhere. 

Some argue that along with these investments in manufacturing 

capacity and R&D facilities overseas, the United States may be 

offshoring some of its capacity actually to innovate. The United 

States has always been a leader in technology development and 

during difficult economic times pulled itself up through R&D and 

innovation. Losing our technological edge is likely to have dire consequences for both our economy and national security. We appear 

to be mortgaging a broad array of assets, pieces of our country’s 

economic future in a historic stampede for short-term gains in corporate profitability and consumer pricing. The mantra or public refrain from the apologists for this spectacle has been that the buggywhip old manufacturing economy has to yield for the United States 

to concentrate on the new American services economy and technological innovation. 

Now, however, as we know, the service economy is being exported as well, cheered on this week by administration officials, no 

less than the chairman of the president’s council on economic advisors. 

More alarming and much more poorly understood is the extent 

to which and in what ways our high-technology capacity and skills 

are following the same pattern. That is why we’re here today in the 

beautiful locale of Southern California. 

Companies in the past have—have in the past faced ultimatums 

when entering the China market. As a condition of investment, 

some U.S. companies have been required implicitly, if not explicitly, to transfer technology and high-tech manufacturing skill to 

China. Now that China has entered the WTO, such conditionality 

4 

is supposed to end. It is, as they say, WTO-illegal. We want to 

know if, in fact, it has ended. 

Moreover, there appear to be other significant factors driving 

companies to send high-tech services and R&D activities to China, 

including proximity to mass—critical mass of manufacturing. 

For whatever reasons, there is no doubt that the United States 

and other foreign companies are helping accelerate China’s technological advancement. 

A key issue that we would like to explore is whether China has 

been able to successfully leapfrog its technological advancement 

due to these technology transfers, or is China actually becoming 

more dependent on foreign technology and, in effect, stifling its 

technological innovative capacities. There are some people who are 

making this argument. 

Furthermore, technological advancement is fueling China’s military modernization. China has focused much of its strategy and 

doctrine on advancements in informational and electronic warfare, 

some of it under a fanciful rubric of so-called asymmetrical warfare, assassin’s mace weapons and the like, tools and concepts 

whereby an inferior power might defeat a superior power. 

If advancement in this area is in any way being fueled by U.S. 

technology exchanges with China, we must understand this and 

fashion appropriate U.S. policies to minimize any security concerns. 

In the region as a whole, China is a high-tech manufacturing 

powerhouse for companies throughout East Asia, particularly Taiwan. We need to understand what this means for Taiwan’s security 

and, more broadly, for U.S. security interests in the region for our 

alliances and friendships there. 

Along with my fellow Commissioners, I look forward to what 

should be a very insightful two days of discussion. And, again, 

thank you for your invitation. And I turn the program over to Ambassador Ellsworth. Mr. Ambassador. 

[The statement follows:] 

Opening Statement by Vice Chairman C. Richard D’Amato 

I join Chairman Robinson in thanking Ambassador Ellsworth for focusing the 

Commission’s attention on the important topic before us and on the unique perspective offered on these issues by the California university and high-technology communities. I also would like to personally commend Dean Peter Cowhey, Professor Susan 

Shirk and the faculty and staff of the Graduate School of International Relations/ 

Pacific Studies for their outstanding effort in developing this two-day event. 

As the Chairman mentioned, we were recently in Columbia, South Carolina investigating the impact of outsourcing and offshoring the U.S. manufacturing base. The 

story is devastating, alarming and rapidly escalating. Action in the Congress to attempt to manage it is all but inevitable. But there is more to the offshoring story 

than manufacturing, as the people of California well know. In corporations’ relentless search for lower costs and favorable quarterly earnings reports, high-tech and 

IT services are moving with increasing frequency to India, China and elsewhere. 

Some argue that along with these investments in manufacturing capacity and R&D 

facilities overseas, the United States may also be offshoring some of its capacity to 

innovate. The United States has always been a leader in technology development, 

and during difficult economic times pulled itself up through R&D and innovation. 

Losing our technological edge is likely to have dire consequences for both our economy and our national security. 

We appear to be mortgaging a broad array of assets, pieces of our country’s economic future in a historic stampede for short term gains in corporate profitability 

and consumer prices. The mantra or public refrain from the apologists for this spectacle has been that the buggy-whip old manufacturing economy had to yield for the 

U.S. to concentrate on the new American services economy and technological innoVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00010 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
5 

vation. Now we know, however, that the service economy is being exported as well, 

cheered on this week by Administration officials such as the Chairman of the president’s Council of Economic Advisors. More alarming and still poorly understood is 

the extent to which and in what ways our high technology capacity and skills are 

following the same pattern. That is why we are here today in the beautiful locale 

of southern California. 

Companies have, in the past, faced ultimatums when entering the China market. 

As a condition of investment, some U.S. companies have been required (implicitly, 

if not always explicitly) to transfer technology and high-tech manufacturing skill to 

China. Now that China has entered the WTO, such conditionality is supposed to 

end. It is ‘‘WTO-illegal’’, as they say. We want to know if it has, in fact, ended. 

Moreover, there appear to be other significant factors driving companies to send 

high-tech services and R&D activities to China, including proximity to a critical 

mass of manufacturing. For whatever reasons, there is no doubt that U.S. and other 

foreign companies are helping accelerate China’s technological advancement. A key 

issue needing exploration is whether China has been able to successfully leap frog 

in its technological advancement due to these technology transfers. 

Furthermore, technological advancement is fueling China’s military modernization. China has focused much of its strategy and doctrine on advancements in informational and electronic warfare, some of it under a fanciful rubric of so-called 

‘‘asymmetrical warfare’’, ‘‘assassin’s mace’’ weapons, and other tools and concepts 

whereby an inferior power might defeat a superior power. If advancement in this 

area is in any way being fueled by U.S. technology exchanges with China, then we 

must understand this and fashion appropriate U.S. policies to minimize any security 

concerns. In the region as a whole, China is a high-tech manufacturing powerhouse for companies throughout East Asia, particularly Taiwan. We need to understand what this 

means for Taiwan’s security, and for U.S. security interests, that is our alliances 

and friendships in the region. 

Along with my fellow Commissioners, I look forward to what should be an insightful two days of discussion. 

OPENING REMARKS OF COMMISSIONER ROBERT F. ELLSWORTH 

HEARING CO-CHAIR 

Co-Chair ELLSWORTH. Thank you, Mr. D’Amato. 

As the chairman and vice chairman have explained, our field investigation here in Southern California addresses the issue of China’s high-tech development and the implications of that development on regional and U.S.-China bilateral relations. 

I thought it would be helpful for the Commission, in fulfilling its 

Congressional mandate, if it came to California to discuss these 

issues with those in the California academic and technology communities who have unique perspectives on these important matters. With the help of Dean Peter Cowhey and Professor Susan 

Shirk we have put together what I believe will be an informative 

session for the Commission. I thank the University of California, 

San Diego, and the Graduate School of International Relations/Pacific Studies for their splendid assistance. 

The rise of China, in my view, is the economic and geopolitical 

event of our age. It is bringing two centuries of global domination 

by Europe and subsequently America to an end. World-transforming change has begun. Measured by purchasing-power parity, 

China is already the second-largest economy in the world, second 

only to the United States, and the world’s largest population by far. 

Its potential for the future is huge. 

For American high-tech companies, China presents both a challenge and an opportunity. While barriers to trade and investment 

have come down following China’s accession to the World Trade Organization, these firms still face an array of obstacles in China, 

from remaining tariffs and nontariff barriers, to China’s weak protection for intellectual property. Moreover, down the road, U.S. and 

6 

other technology firms likely will face increasing competition from 

Chinese domestic firms whose technological advancement is on the 

fast track. China’s cell phone consumption is the highest in the 

world, and it’s a major market for semiconductors. It has become 

a growing center for high-tech manufacturing and in some cases research and development for global technology firms. 

As a result, China plays the role of lucrative market to high-tech 

companies, as well as a cost-effective production and research base. 

The Commission seeks to understand these dynamics, particularly 

the rapidity with which China is developing its high-tech capacities, as they pose issues for both our economic competitiveness as 

well as national security concerns where certain sensitive or military-related technologies may be involved. The quality of China’s 

military modernization program is impressive, albeit the quantities 

are small. Most of China’s effective military power threatens Taiwan. Precision-guided missiles, strike aircraft, fast-attack submarines, nuclear and space capabilities—all are being modernized. 

A second major issue that will be addressed during our field investigation is how these dynamics are affecting trade and investment trends for the Asian region as a whole. The reexport of hightech manufacturers through China has changed the investment 

and trade flows of the region. China’s major role in the global supply chain for technology goods and its corresponding economic clout 

is impacting the political landscape of Asia. The Commission needs 

to assess these trends and their implications for U.S. interests in 

the Asia region. Now, let me just briefly forecast the flow of events 

today and tomorrow. Following an introduction by Dean Cowhey on 

China as an Emerging High-Tech Giant, the morning portion of 

this hearing will consist of two panels. 

The first will explore the current trends and future challenges in 

China’s economy. Professor Barry Naughton of UCSD, Professor 

Scott Rozelle of UC, Davis, and Professor K.C. Fung of UC, Santa 

Cruz, will speak about the economic trends in China’s rural areas 

and the thriving economy of its foreign-invested eastern coast. Second panel will examine China’s role in regional production and investment networks. Professors Gordon Hanson, Stephan Haggard 

and Richard Feinberg, all from UCSD, will testify. During the second portion of the day, the Commissioners will have an opportunity 

to dialogue with California’s high-tech industry leaders. The afternoon will begin with a panel focusing on the biotechnology industry. Dr. Lee Zhong, president of NatureGen and Elene Pharmaceuticals; Mr. Greg Lucier, president and CEO of Invitrogen Corporation; Mr. Joseph Panetta, president and CEO of BIOCOM; and 

Dr. Kerry Dance, managing partner of Hamilton Apex Technology 

Ventures, LP, will join the Commission. 

The final two panels will cover a range of other key high-tech industries. We will have a panel with William Bold, vice president 

of government affairs for QUALCOMM; Jason Dedrick of the Center for Research on Information Technology and Organization, UC, 

Irvine; and Dr. Francine Berman, director of the Supercomputer 

Center, UCSD. 

They will testify from the perspectives of the telecommunications, electronics manufacturing and supercomputing industry, 

respectively. During the last panel of the day, the Commissioners 

7 

will hear from Dr. Michael May of the Center for International Security and Arms Control, Stanford University, who will focus on 

the energy industry. 

Our field investigation will conclude tomorrow with a round-table 

discussion on China’s role in Asia. 

Professors Susan Shirk and Ellis Krauss of UCSD and Professor 

David Lampton of the Johns Hopkins School of Advanced International Studies will participate. 

Again, I want to thank UCSD and especially the Graduate 

School for their help in putting together our two-day event and look 

forward to the testimony. 

And our chairman, Roger Robinson, will have the honor of introducing Peter Cowhey. 

Opening Statement by Commissioner Robert F. Ellsworth 

Hearing Co-Chair 

As the Chairman and Vice-Chairman have explained, our field investigation in 

Southern California addresses the issue of China’s high-tech development and the 

regional and U.S.-China bilateral implications. I thought it would be helpful for the 

Commission in fulfilling its Congressional mandate if it came out West to dialogue 

on this issue with those in the California academic and technology communities who 

have unique perspectives on these important matters. With the help of Dean Peter 

Cowhey and Professor Susan Shirk, we have put together what I believe will be an 

informative session for the Commission. I thank UCSD and the Graduate School of 

International Relations/Pacific Studies for their first-rate assistance. 

The rise of China in my view is the economic and geopolitical event of our age. 

It is bringing two centuries of global domination by Europe and subsequently, America, to an end. World-transforming change has begun. Measured by purchasingpower parity, China is already the second largest economy in the world—second 

only to the United States—and the world’s largest population by far. Its potential 

for the future is huge. 

For American high-tech companies, China presents both a challenge and an opportunity. While barriers to trade and investment have come down following China’s 

accession to the World Trade Organization (WTO), these firms still face an array 

of obstacles in China, from remaining tariffs and non-tariff barriers to China’s weak 

protection for intellectual property. Moreover, down the road, U.S. and other technology firms likely will face increasing competition from Chinese domestic firms 

whose technological advancement is on the fast track. 

China’s cell phone consumption is the highest in the world and it is a major market for semiconductors. It has become a growing center for high-tech manufacturing, 

and in some cases research and development, for global technology firms. As a result China plays the role of lucrative market to high-tech companies, as well as a 

cost effective production and research base. The Commission seeks to understand 

these dynamics—particularly the rapidity with which China is developing its hightech capacities—as they pose issues for both our economic competitiveness as well 

as national security concerns where certain sensitive or military-related technologies 

may be involved. 

The quality of China’s military modernization program is impressive, albeit the 

quantities are small. Most of China’s effective military power threatens Taiwan. 

Precision-guided missiles, strike aircraft, fast-attack submarines, nuclear and space 

capabilities—all are being modernized. 

A second major issue that will be addressed during our field investigation is how 

these dynamics are affecting trade and investment trends for the Asian region as 

a whole. The re-export of high-tech manufacturers through China has changed the 

investment and trade flows of the region. China’s major role in the global supply 

chain for technology goods and its corresponding economic clout is impacting the political landscape of Asia. The Commission needs to assess these trends and their implications for U.S. interests in the Asia region. 

Following an introduction by Dean Cowhey on ‘‘China as an Emerging High Tech 

Giant,’’ the morning portion of this hearing will consist of two panels. The first will 

explore the current trends and future challenges in China’s economy. Professor 

Barry Naughton of UCSD, Professor Scott Rozelle of UC Davis, and Professor K.C. 

Fung of UC Santa Cruz will speak about the economic trends in China’s rural areas 

and the thriving economy of its foreign invested eastern coast. 

8 

The second panel will examine China’s role in regional production and investment 

networks. Professors Gordon Hanson, Stephen Haggard, and Richard Feinberg, all 

from UCSD, will testify. 

During the second portion of the day, the Commissioners will have an opportunity 

to dialogue with California’s high-tech industry leaders. The afternoon will begin 

with a panel focusing on the biotechnology industry. Dr. Lee Zhong, President of 

NatureGen and Elene Pharmaceuticals, Mr. Greg Lucier, President and CEO of 

Invitrogen Corp., Mr. Joseph Panetta, President and CEO of BIOCOM, and Dr. 

Kerry Dance, Managing Partner of Hamilton Apex Technology Ventures, LP will 

join the Commission. 

The final two panels will cover a range of other key high-tech industries. We will 

have a panel with William Bold, Vice President of Government Affairs for 

Qualcomm, Jason Dedrick of the Center for Research on Information Technology 

and Organization (UC, Irvine), and Dr. Francine Berman, Director of the Supercomputer Center (UCSD). They will testify from the perspectives of the telecommunications, electronics manufacturing and supercomputing industry, respectively. During the last panel of the day the Commissioners will hear from Dr. Michael May 

of the Center for International Security and Arms Control (Stanford University) who 

will focus on the energy industry. 

Our field investigation will conclude tomorrow with a roundtable discussion on 

China’s role in Asia. Professors Susan Shirk and Ellis Krauss of UCSD and Professor David Lampton of the Johns Hopkins School of Advanced International Studies will participate. 

Again I thank UCSD and the Graduate School for their help in putting together 

our two-day event, and look forward to the testimony. 

Chairman ROBINSON. Thank you, Ambassador Ellsworth. Indeed 

it is an honor. We’re beginning with remarks by Dean Cowhey, for 

which we’re grateful, that go under the title ‘‘China as an Emerging High-Tech Giant.’’ As all of those assembled here know, Dean 

Cowhey is dean of the Graduate School of International Relations 

and Pacific Studies, as well as director of the Institute on Global 

Conflict and Cooperation. He holds the QUALCOMM-endowed 

chair in communications and technology policy. 

Dean Cowhey is an internationally recognized expert in telecommunications and information policy and markets, who’s a leader in building cooperative international arrangements for the management of security and economic issues. He served in the Clinton 

Administration for some three years as head of the International 

Policy and Regulation Division of the Federal Communication Commission, as well as an advisor to the U.S. trade representative. 

He’s widely credited as having been the moving force behind the 

successful completion of a global trade agreement in 1987 at the 

World Trade Organization, to open up competition in basic telecommunications markets. Dean Cowhey remains dedicated to 

hands-on service and advocacy in creating the next networking and 

information technology revolution. He not only serves on the advisory boards of the United Nations Development Program and U.S. 

Agency for International Development, but has been an advisor to 

over 50 countries seeking to reform their communications markets, 

as well as corporate giants, such as QUALCOMM, AT&T and others. He currently serves as chairman of the board of Digital Partners, a global nonprofit organization that works on harnessing digital technology for economic and social development. Now, I could 

go on, believe me—it’s a very distinguished resume—but I will stop 

here and say that one thing is clear, that Dean Cowhey is a visionary, a scholar and one who has been a leading light in the very 

fields that we’ll be discussing today. 

9 

We’re most grateful to be here, again, and thanks again to Dean 

Cowhey and Professor Shirk for all they’ve done to make this event 

possible. And with that, I would be very pleased to turn the floor 

to you, sir. 

INTRODUCTION: CHINA AS AN EMERGING HIGH TECH GIANT 

STATEMENT OF DEAN PETER COWHEY 

GRADUATE SCHOOL OF INTERNATIONAL RELATIONS AND 

PACIFIC STUDIES 

UNIVERSITY OF CALIFORNIA, SAN DIEGO 

Dr. COWHEY. Thank you very much for those kind remarks, 

Chairman Robinson. And as the Dean of the Graduate School of 

International Relations and Pacific Studies here at the University 

of California, San Diego, I would like to welcome you to this university. 

We knew that you were coming and this would be an important 

occasion, so we decided to put up a new hall in your honor. This 

is called the Great Hall, forms a symbol that may indicate the Pacific orientation of meeting places here in California. 

As the largest school in the United States that’s devoted to training professionals for the Pacific region, we believe deeply in the 

value of conversations and public debate about the key relationships in the region. And there’s certainly no relationship that is 

more important to the future of the Pacific than the relationship 

between the United States and China. And, indeed, in the long 

haul of the 21st century, there may be no single bilateral relationship in the world that is more important to the world. 

We’ve worked hard with the staff of the Commission to make 

sure that you have an opportunity to hear insightful voices from 

both the West Coast technology community and from our community of experts on China and Asia. Much of the expertise in the 

United States on China is located here on the West Coast. But 

even in this age of the Internet, geography creates a barrier to policy discussions between the West and the East Coast. So today and 

tomorrow that barrier’s being dissolved by your decision to come 

here. For that, we are thankful. And I’m confident that both the 

people who are presenting to you and I hope those of you on the 

Commission will learn much from this discussion. I also want to 

express our special thanks to Ambassador Ellsworth and Vice 

Chairman of the Commission D’Amato who worked closely with us 

here at the Graduate School in forging this particular program and 

giving us guidance on how we can be helpful to you. 

Now, my job today is to go beyond offering greetings, which is 

usually what they restrict deans to doing, to trying to provide an 

overview of a larger context about the issues that your Commission 

is grappling with. I want to begin by acknowledging that you have 

a very serious challenge to protect the economic and security safeguards of the U.S. and offer candid advice to Congress about that. 

There are, no doubt, many hard decisions that have to be made 

about dealing with specific problems. But I would like to begin by 

stepping back from the specifics of both the bilateral relationship 

and the immediate charge of the Commission, to looking at the 

larger context in which the Commission and our bilateral relationship exists, namely, by looking at issues of the future of the Pacific 

10 

and also of science and technology relations in the Pacific. And 

then I will close my remarks by looking more specifically at the 

possibility of China becoming, if you would, a coequal with the U.S. 

and technology leadership. Is that a credible worry, or is that something that is perhaps overblown? I believe that any history textbook that’s used in the late 21st century will surely dwell on two 

transformations in the Pacific since 1945: First, the Pacific, which, 

for simplicity’s sake, I’ll simply define as the Americas and Asia, 

has emerged as the dominant pivot of the world economy in the 

second half of the 20th century and certainly the beginning of the 

21st. 

It is the center of gross domestic product. It is the center of technology innovation and production. It is the center of many of the 

largest military challenges in the world. It is the center, in fact, of 

many of the largest global environmental challenges. 

Now, Asia has been more important than Latin America in driving this shift in the world economy from the Atlantic to the Pacific, 

but countries like Brazil and Mexico will surely play a larger role 

in the next 20 years in this economic and technological transformation of Pacific leadership. 

Now, the second thing that has occurred is that Asia has 

emerged, or maybe in a great historical sense reemerged as a major 

center for technology production and innovation. Your Commission 

is dealing with the U.S.-China relationship. But, in fact, this is 

playing out a cycle that began almost 30 years ago. 

Japan’s emergence as a major economic power in the 1970s was 

fueled by evermore sophisticated technological offerings, and it was 

simply the first round of change in Asia. Korea soon became a technology power that rivals France, and Taiwan is the center of some 

of the most advanced technology manufacturing systems in the 

world. 

Along with that we have the specialized, if you would, boutique 

design and production centers tied to multinational corporations 

around Singapore and Malaysia. 

And, finally, in the latest round, China and India have stepped 

forward with all their scientific expertise and huge population resources to complete this innovation cycle across Asia. Now, it’s important that we keep a steady eye on this historic transformation 

in order to put the U.S.-China relationship into perspective. I want 

to make two claims this morning. The first is fairly sweeping. The 

building of a Pacific community is one of the paramount foreign 

policy challenges for the U.S. in this century, and science and technology policy is going to be a large part of that challenge. And the 

second and somewhat narrower claim is that any policy for science 

and technology relations between the U.S. and China must situate 

that bilateral relationship and its policies within an understanding 

of the larger regional innovation and production cycle that has 

emerged in the Pacific. 

I once learned from a great history professor that the bigger the 

claim, the briefer should be the justification, because there’s always 

going to be a million details wrong about the big proposition, but 

the big core insight should be relatively simple. So I’m going to 

offer you my two-minute guide to each of these broad-sweeping 

claims. 

11 

First, why is building a Pacific community a paramount challenge? Well, the same 21st century textbook will note that the first 

half of the 20th century had two world wars and a great depression. As the center of the world’s military, political, economic and 

technological power of that era, namely, the Atlantic region ranging 

from here in the California through the Euros, struggled to find a 

modus vivendi to manage rapid changes in national competitive positions and national strategies. 

It was only after that terrible turmoil in the second half of the 

20th century that we emerged by the very rough standards of justice of history in an era of major power peace, despite the Cold 

War, and an unprecedented sustained prosperity economically and 

technological innovation in the core of the world economy. And at 

the same time, Europe emerged as a thoroughly Democratic society, and we built a transatlantic web of diplomatic military and 

economic institutions that truly created an Atlantic community. 

Paris and Washington may anger each other, but this is fundamentally a family feud, not a warfare between clans. 

By most metrics, the Pacific has now superseded the Atlantic as 

the center for the world’s economic, technological and military 

power. 

The question that is starkly facing American foreign policy is 

simple. Will we duplicate the record of the Atlantic in the 20th century, requiring 50 years of woe before getting it right, or can we 

find a way of producing a Pacific community consistent with democracy, prosperity, innovation, sustainable environmental relations more quickly and less painfully? Now, I have to tell you that 

I’m no advocate of Wizard of Oz diplomacy, you know, click your 

heels three times and you’ll get to exactly where you want in the 

world, whether it be Kansas, Ambassador Ellsworth, or California. 

But for the sake of our children and our grandchildren, we 

shouldn’t lose sight of this bigger picture. In an era surging technological innovation and globalization, science and technology policy 

is going to be a large part of this Pacific community story and simply because those are the tools for building faster economic growth 

and giving us the tools for attacking our common problems, such 

as the management of disease. 

Market forces and sound policy can let the U.S. lead this technological revolution on a continuing basis. But we can’t lead by sustaining our leadership through restricting the sharing of technology 

with all those who are willing to play by sensible global rules. 

And moreover, in the last part—in this coming century, even 

more so than the last century, as I think you’ll hear in the testimony, science is going to be a truly unified global effort. And many 

of the ways that we thought about national rivalries and technology don’t quite play out the same way in the future as they did 

in the past. 

Now, my second claim is simply that we shouldn’t ignore the regional production and innovation cycle and technology in the Pacific as we deal with the bilateral relationship. 

I’ll remind you that in the early 1990s there was a consensus 

emerging in the business press and in many government circles 

that the U.S. was about to be eclipsed by Japan in communications 

and information technology. But suddenly overnight that changed. 

12 

Why did that happen? Well, probably the two most important factors shifting the balance of power between the U.S. and Japan involved the creation of a Pacific supply chain for production and innovation and the role of competition and empowering innovation. 

I want to talk about both of those because they somewhat recast 

some of the discussions that perhaps you often hear about the U.S.- 

China relationships. 

You recall that Japan seemed to be surpassing the U.S. because 

of its clever design of vertically integrated production and marketing operations, which they supplemented by strategic protection 

of the home market. And over time, slowly Japan was seeming to 

grind down the American technology leadership. Now, U.S. industry responded by getting the U.S. Government to push harder to 

open the Japanese market, something that I thoroughly supported 

at the time. And that certainly helped, but it did not suffice. 

The U.S. success in responding to Japan came because industry 

itself reinvented its systems of production and innovation. And in 

particular, the U.S. invented a whole new way of building an international network to coordinate specialized design and production 

partners in Southeast Asia, Taiwan, Korea on the one hand and 

Mexico on the other. 

And it was by utilizing the expertise, initiative and money of its 

foreign partners in a sophisticated information and incentive network that U.S. firms were able to trump their Japanese counterparts. 

Japan moved to production overseas, but it was essentially a 

Japan-incorporated affair, moving their own firms to those places 

and running the same hierarchical Japanese system. American 

firms learned how to coinvent, coproduce and coinvest. And in that 

you found a major shift in competitive advantage. Now, that complex division of labor led by U.S. production chains involving Taiwan and Southeast Asia has now spread to an even more complicated chain involving China, Southeast Asia and India. 

And this is almost being redefined on a monthly basis. My point 

is that this is not an alternative to U.S. production and invention. 

It is a complement and a coinventor with U.S. leadership. 

Now, a second key to the American resurgence in the early 1990s 

was simply the competition-fueled innovation in the United States 

in unexpected ways. Both the Internet and the World Wide Web 

figured in none of the technology-planning documents that could be 

found in European and Japanese firms. And equally importantly, 

it didn’t appear in the planning documents of AT&T. All right. 

What happened in the United States was that because of innovative capital markets, a vast investment in having competitive, decentralized small firms through our science and technology and internal competition policies, we got a bunch of upstarts who didn’t 

believe in the standard business models and didn’t believe in the 

standard technology plans of the giants. And if you want to rewrite 

the history of communications and information technology in the 

’90s, ask companies like Siemens, Fujitsu and Alcatel exactly how 

much trouble companies like Cisco, QUALCOMM and Dell created 

for them. All right. 

13 

Those companies, in turn, could not have succeeded in their 

strategy without the coinvention in innovation cycle that they created in the Pacific. 

Now, this Commission has an important job in pointing out to 

areas where the U.S. policy can continue to accelerate our innovation and leadership to make sure that we remain the anchor of the 

world technology community. And you certainly should address 

specific issues about trade and security policy that are created by 

interdependence, but we must remember this larger cycle as we 

evaluate our long-term strategy. So let me turn to the last part of 

my remarks, which is really focusing on whether China can compete seriously with the U.S. for technological leadership. 

In addressing this, I am going to fall back on my narrow area 

of expertise about communications and information technology simply because any attempt to assess comparative national metrics is 

tricky enough in itself, and at least here I know where my worst 

mistakes could be made. Let me start by stipulating something, 

which is that what I want to do here is simply ask, could China’s 

use of the Internet as an engine to fuel technology innovation propel it to a deeper and broader technology parity? The Internet represents not just the Internet services themselves, but also a new 

communications infrastructure, supporting hardware and software. 

So it’s an engine for technological innovation, not just a set of services to use as we surf on the Web. 

And I would like to further stipulate that we should not be surprised if a large, low-income country with a substantial pool of scientists and engineers won’t make some significant advances in the 

commercial marketplace for technology. It almost has to happen. 

The real question is whether selective successes are translated 

into a general upgrading of China’s technology position, and, if so, 

how fast and how deeply? 

And in this I would like to especially focus on Chinese government policy. Now, as I look at this, let me add a final stipulation. 

What we have learned from the Asian technology miracle of the 

last 30 years is that government intervention in marketplaces can 

accelerate technological upgrading of economies. 

There is no doubt that that’s a central lesson from both Japan 

and Korea, but those same casebooks would tell us that government policy doesn’t always get it right. The same Japanese policies 

that propelled Japan to challenge the U.S. in communications and 

information technology until the early 1990s also dealt a serious 

blow to Japanese competitiveness by not knowing how to adapt 

quickly enough to the demands of the Internet. 

The stakeholders, if you would, in the old Japanese industrial 

policies wouldn’t consent to letting the market shift in response to 

the Internet innovation. 

So government policy both has its strengths and its weaknesses 

in this story. Now, to explore the story of China’s ability to challenge the U.S., I’m going to begin briefly skimming over a few of 

the factors that suggest that it’s going to be hard for China to move 

to serious competitive parity in technology with the U.S. 

And then I’m going to turn and look at how Chinese government 

policy might leverage some strengths of China into parity. So it’s 

for skeptics and then people who believe that there is a serious 

14 

challenge, each being examined. The skeptics’ case, which I will, for 

the sake of time, only move through briefly, begins fundamentally 

with the fact that the gap between the United States and China 

in technological strength is enormous. And this is reinforced by 

huge differences in the basic infrastructure of the two economies. 

I have presented the Commission with a large number of tables 

with data to look at this issue selectively. And Tables 1 through 9 

might be thought of as the case of skeptics being illustrated by 

data about the Chinese challenge. Rather than review those tables 

in detail, let me instead point to a few of the things that leap out 

from those tables. The first is simply that the research and development effort between the United States and China remains enormously large. Gross domestic product advocated to R&D in China 

is about 1 percent. In the U.S. it’s 2.7 percent in a much larger 

economy. 

More deeply, if you take a look at the same technology products, 

let’s say electronics, between the United States and China there is 

an enormous difference in the comparative value added of the two. 

In the United States the value added of those products created 

by R&D is about 22 percent. In China, it’s about 5 percent. You 

may call them both computational products, but one is the product 

of an intensive R&D; the other is essentially a commodity product 

still. Now, a second factor that would leap to mind if you looked 

at the infrastructure for innovation are fundamentals like the communications infrastructure. There are tables that I’ve presented to 

you showing you that the bandwidth for high-speed data communications, which is a key to innovation in the next 25 years, is 

hugely different between the United States and China, and it creates enormous indirect competitive advantages for the United 

States. Similarly, if you do measures of the stock of intellectual 

property or the ability to create it in the short term, there still remains overwhelming gaps. The OECD average of patents per 1 million people is close to 150, and, of course, the U.S. far exceeds that. 

The level in China is 5. All right. 

So there are enormous differences in the starting point of the two 

countries. And those differences, despite rapid Chinese growth, 

suggest a substantial lead for the United States for the foreseeable 

future. 

Now, that is what a skeptic would start by saying about the Chinese claim to hoping for parity. But let me turn to a second factor 

about the case for parity and Chinese leadership. Any case that 

China is going to move up against the United States depends on 

assuming that the Chinese government’s intervention in its economy will work successfully for achieving parity. That is, it will have 

successful R&D technology and industrial policies. There is no 

doubt, I think, that the Chinese interventions will in many ways 

be fruitful, just as those in Japan and Korea were fruitful. The 

point I simply want to point you to is remember the other side of 

the Japanese and Korean record when government policy went 

wrong. This is not surprising. It’s not particularly unique to Asia. 

In the United States Professors Linda Cohen and Roger Noll have 

written a magnificent study called ‘‘The Technology Pork Barrel.’’ 

And the point of the study is that U.S. research and development 

policy at the government level is certainly the best-disciplined, 

15 

best-focused and really most quality-oriented R&D program in the 

world. But it is also characterized by huge amounts of expenditures 

that look a lot like roads and harbors and ports. One of the reasons 

why the war on cancer defined the biotechnology research of agenda for years was why? Because you could fight cancer in every congressional district in the United States. And often expenditures on 

cancer exceeded other bio priorities simply because of that. Now, I 

won’t go through the formal litany of analysis, but let me give you 

a flavor of one effect of these sorts of political dynamics in China. 

Any review of the hardware and software industry for communications and information technology in China in comparison to 

India leads to a single conclusion. China has specialized in hardware; India has specialized in software. But we know one of the 

reasons why that has occurred in China. And the reason is, is that 

it is politically popular to point to the creation of larger hardware 

sales and exports as a measure of success of Chinese communist 

policies. Yet, in fact, the real growth factor in this industry by any 

metric we have outside of China is really in the software side of 

the industry. 

So China has made a bet in its early technology policy that is 

not an optimal bet. Now, it doesn’t prove that China won’t correct 

that bet later on, but we should be aware that government policy 

has a two-sided edge, both good and bad. 

Nonetheless, I am not trying to gainsay the fact that China has 

some strategic advantages that could propel it forward. 

Again, I’ve presented a number of tables in my background testimony that I don’t intend to go into at great length, but it’s surely 

true in the information and communications industry that we can’t 

ignore a compound annual growth rate of 27 percent in the Chinese 

market. China is now the third largest communications network 

service market measured by the number of users, and it has the 

third largest personal computer base in the world. Moreover, about 

19 percent of its exports can now be classified as high tech in manufacturing, and they have been upgrading the manufacturing output of China towards a technology base steadily over the last eight 

years. Just as significantly I would draw your attention that the 

high-tech exports of China and Hong Kong together, which ought 

to be thought of as a single unit for this purpose, now exceed $100 

billion a year. That’s just a little behind Japanese high-tech export 

levels. That’s a dramatic increase. 

Let me turn to the last point I want to make before turning to 

the point of Chinese government policy, which is that foreign research in China has grown. I present evidence in this in my testimony. But it’s unclear yet whether this is fundamentally basic research or it’s applied product engineering. 

How can government policy in China leverage the last great leap 

forward? What you need to be paying attention to about the misuse 

of government power. Let me just mention four points. First, the 

Chinese government has used government procurement as a strong 

leverage point for promoting Chinese firms and technology. Government procurement remains a lever for technology policy. 

Two, China’s employed proprietary technology standards to shift 

the terms of competition in favor of Chinese technology. Now, the 

creation of proprietary national standards are not new or unique 

16 

to China. The U.S. television industry has used this ploy many 

years and many times. 

But what is important in China is that China is first developing 

those standards giving the bait to Chinese—to foreign producers 

that the large internal Chinese market justifies a proprietary 

standard. And then once they get economies of scale, they’re encouraging the growth of exports out of China with those new standards. It’s a clever positioning off of the Chinese market. 

Finally, the Chinese government is using its powers over state 

corporations, in particular, and over companies that require licenses to produce or provide services to organized bargaining cartels with foreign suppliers, whether on the terms of royalties or on 

the terms of technology licensing. This is not a direct government 

mandate. You can’t find it written down in the formal regulation. 

You simply give guidance through the licensing process or through 

the budget review of the state enterprises in order to drive the 

market. 

Much as we had to unravel the indirect controls of the Japanese 

government over the Japanese economy, we have to continue to unravel these Chinese controls. 

As we deal with these specific issues and intentions, we will at 

times run into conflict; but in the long term, our welfare as a society fueled by technological innovation and our prosperity as a competitor in the world as a producer of high-tech goods and services 

depends on keeping the Pacific innovation community alive, recognizing that China is going to become a central part of that community and figuring out how we can manage this relationship so that 

for all of our sakes, both here and in China, in the long term we 

can prosper even as we deal with the challenges. 

Thank you for being here today. 

Chairman ROBINSON. Well, thank you for that extraordinary tour 

de force to serve as a framework for our proceedings today. I was 

impressed with so much of what you’ve said, and certainly that— 

the comment concerning India on the software side, China on the 

hardware side is one of the great markers, if you will, for the 21st 

century as we look at the emerging giants, so to speak. 

And underpinning of so much of what you’ve said and so much 

of what our Commission tries to grapple with on a day-to-day basis 

in exploring our rather broad-based mandate is, of course, the dynamic that is constantly underpinning these developments between 

sustainable economic and technological dynamism and innovation 

and the need for strength and political pluralism and individual 

liberties, which gets to the heart of will the Internet be that engine— 

Dr. COWHEY. Right. 

Chairman ROBINSON. Thank you for your presentation. 

And I would like to turn over the morning’s proceedings to the 

vice chairman of our Commission, but also the cochairman of this 

hearing, Dick D’Amato. 

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

And I also would like to join the Chairman in thanking you, Dr. 

Cowhey, for an unusually thoughtful and excellent presentation. It 

provides a framework for questions that we should be including in 

our inquiry. I think that the appropriate perspective for us is to 

17 

look at Pacific as a region. And we sometimes get diverted to some 

of the more specific concerns we have about the China relationship, 

such as the chairman mentioned in terms of the Internet. We had 

a long investigation on the Internet issue in association with the 

SARS question. And any kind of issue dealing with innovation on 

the Internet also needs to consider how one can really be a competitive innovative power at the same time you control those forces 

of innovation. It just doesn’t seem, in the long run, to work very 

effectively. 

Actually, we have been successful in getting a recommendation 

through the Congress in this latest appropriations bill to do a pilot 

program in terms of actually breaking through that Internet firewall. 

We know that there are some technology companies in the 

United States that can do that, and we’re going to give them some 

money to show us how they can continue to do that and broaden 

the access of the average Chinese computer user to the World Wide 

Web without censorship. We think that will help be very valuable. 

I also would like to commend you in terms of looking at the question of the role of government in all of this. Of course, this Commission is a Government Commission. We’re created by the Congress 

to provide the kind of practical recommendations and insights for 

action by the Congress in terms of enhancing American interests 

in the region. 

And so we’re going to be trying to take away from this hearing 

and your remarks some ideas that we can give to the Congress in 

terms of actions that they might consider in the upcoming year. 

I might mention that we usually have members of Congress or 

the Senate testify before us. We did invite Congressman Duncan 

Hunter, Susan Davis, Senators Feinstein and Boxer to the hearing. 

They had something better to do on the other side of the country. 

They are in session in Washington were not able to come today. We 

do have some staff members from those offices here today. We welcome them, and we’ll be back to their members with our hearing 

record. 

So we’ll do a hearing record. All these statements will be included in the record. And we will publish that within two weeks 

and distribute that widely. Mr. Mulloy, do you have a question? 

Commissioner MULLOY. Dr. Cowhey, thank you. Your presentation was very helpful. I want to look at this in the broad context 

in which you’ve given it. My father served in World War I, so I do 

have that broad sweep from listening to him and then seeing what 

happened after World War II. And we built multilateral institutions to help us assure that those types of events would not come 

on us again, at least try to manage them. My sense is that the 

United States, through actions like creation of the WTO, China’s 

entry into the WTO and other things, we’ve put ourselves into a 

globalized economy. I don’t think we fully understood the historical 

forces that we were setting loose by doing this. Senator Schumer 

and Paul Craig Roberts, who was an assistant secretary of the 

treasury under Ronald Reagan, a former free-trader, who are saying that what we’ve got here now is not Ricardo-type trade based 

on comparative advantage, because now the factors of production, 

technology and the capital are loose worldwide. And people who 

18 

had the technology and capital who could monopolize are now not 

going to be doing that. Now, if you’re looking at the United States, we have a $500 bil- lion current account deficit, $125 billion trade deficit with China. 

If you’re watching the presidential campaigns, you’ll see that out 

there in the heartland there’s a lot of hurt with loss of jobs and 

a sense of a downgrading of the standard of living for a lot of people in the country. 

So I think it’s interesting that these are the political realities 

that we’ve got to contend with as we’re talking about these larger 

trends that you put before us. 

Specifically, you have a chance to tell the President, what are the 

three or four things that we ought to be doing to prepare our society to compete—to compete in this globalized economy? I think 

that’s what we need to be helping think about and particularly 

with China. What would be the three or four things that you say, 

okay, bang, bang, bang. These are the things that are going to correct some of these trends, which are very, very politically explosive 

right now. 

Dr. COWHEY. Well, that’s a very thoughtful and big question, and 

I don’t want to do my professor’s routine where I could give you 

a 20-week lecture about it. But let me instead mention bang, bang, 

bang, a few things that I think are important. 

The first is that there is absolutely a need to reinvest at the 

highest possible levels in our long-term human, you know, capital 

investment for advanced leadership in the people who make technology work, and along with it the infrastructure. 

One of the things that you observe in our R&D budgets in the 

United States is fundamentally that we aren’t investing in a lot of 

the infrastructure that we alone can afford and creates an enormous leverage in the United States. A second point, because that 

may sound like self-pleading from a research university professor, 

is that I think that we have to take seriously the question of the 

adjustment of labor markets because it’s going to be more volatile 

than in the past. 

It used to be that we expected that industries that were underchallenged in foreign trade would decline on some steady metric. 

And we’d protect them a little bit, we’d subsidize them a little bit, 

but they would be declining. And the time would sort of allow for 

the adjustment. 

But this world that we’re living in with deeper liberalization and 

faster changes in competitive advantages is going to displace a lot 

more workers and families a lot faster. I’m going to offer a thought 

that is not, I would say, commonly expressed, but let me just put 

it boldly. There is an enormous scholarly literature on trade that 

says that the cost of protecting jobs is very, very high. It’s in the 

millions of dollars per job typically. Yet how do we compensate unemployed workers? We usually say, well, we’ll give you a retraining 

program. We’ll give you unemployment benefits for a number of 

weeks. 

How much do we spend on that? Do we spend 100,000, 200,000? 

I don’t know what the exact number is on average. 

What if we just simply said as a society that for every trade-related displaced job in the long term—and there are ways you can 

19 

define that—that we will simply make a payment of an annuity of 

$1 million to the displaced worker? Why not say that we recognize 

that there is a cost for workers of the adjustment of the economy 

and invest seriously in workers in a social bargain about that? I 

don’t know if that number is right. What I’m saying to you is that 

it’s—we need a different social contract than simply worker retraining and unemployment. And the third thing I would say to 

you is that fundamentally, the problems that we are dealing with 

is going to require a larger growth of institutions for the Pacific. 

The Atlantic success of the second half of the 20th century didn’t 

come just because of NATO. 

It came because there was NATO, there was the European union, 

there was the World Bank and the Marshall Plan. All those things 

came together—the Fulbright Program. 

We have to bring all those things together so that there are some 

shared problems that everybody is working on that leads us to 

treat the adjustment problem not just as a U.S. problem, but a 

shared problem of all the industrial players. And I think that that’s 

going to be a key challenge for diplomacy. 

Vice Chairman D’AMATO. Thank you very much, Dean Cowhey. 

We’ll go ahead now and move to our first panel. We have three 

members of the intellectual establishment, university community, 

with us: Dr. Barry Naughton, Dr. Scott Rozelle and Dr. K.C. Fung. 

Let me just lay out for you our ground rules and how we’ll organize ourselves. We would like each of you—we have your testimony, and we will include your testimony in full in our hearing 

record. We would like to ask you to give us an oral presentation 

as long as you like, up to about eight minutes, if you would. And 

we’ll have each of you give that in series. So we’ll have three eightminute presentations, and then I’ll open it up to Commissioners, 

who will then have five minutes for your questions and answers for 

the panel. 

Why don’t we start from right to left. Would you like to start, Dr. 

Naughton? Thank you. Go ahead. 

PANEL I: THE CHINESE ECONOMY: CURRENT TRENDS AND 

FUTURE CHALLENGES 

STATEMENT OF BARRY NAUGHTON, Ph.D. 

PROFESSOR OF ECONOMICS 

GRADUATE SCHOOL OF INTERNATIONAL RELATIONS AND 

PACIFIC STUDIES 

UNIVERSITY OF CALIFORNIA, SAN DIEGO 

Dr. NAUGHTON. Thanks very much. It’s a tremendous honor for 

us to host you here at UCSD. There’s some familiar faces among 

you and some new friends, and it’s a great honor for us to be here 

and have you here, as well. So thank you very much for giving us 

this opportunity to testify. 

I would like to take a look at—a little bit more specifically at the 

Chinese economy. Chinese economy is exploding. At a GDP growth 

of 9 percent last year despite the SARS epidemic, it’s the fastestgrowing economy in the world. And in the high-tech sector—let me 

just put one number on the table. Exports of computers and components from China last year increased 104 percent in a single year. 

It’s astonishing, the magnitude of change that’s going on in China. 

20 

What I would like to do in my eight minutes is try and link some 

of these processes in China to the structure of the Chinese economy 

and then talk about a few of the implications for United States’ interests. 

But let me say at the outset that I follow very much in the spirit 

and analytic framework of Dean Cowhey’s remarks. 

Although China’s rapid growth certainly poses some competitive 

and rivalry factors for the United States, one of the themes that 

will run through my remarks is the surprisingly strong partnerships that link U.S. firms, Taiwan firms and Chinese firms. 

If we want to talk about high-tech development in China, we 

have to think about Taiwan and the United States because these 

are the two key actors in making the dramatic changes that we’re 

talking about happen. Until very, very recently it made sense to 

think of China as two separate economies: a domestic economy that 

was fairly protected, where the government tried to shape economic 

outcomes, and an external economy that was extremely open, dominated by foreign investors, especially Hong Kong, Taiwan and U.S. 

investors and where goods moved in and out of the economy quite 

freely and without much government intervention at all. These distinctions are now dissolving. This dualistic economy is changing in 

fundamental ways, and the two spheres of the economy are starting to interpenetrate. 

Domestically, the state has retreated in very important ways, 

both from industrial policy and from direct state ownership. The 

number of people working for state-owned firms in China has reduced 45 percent in the last five years. 

The state sector is half the size it used to be even as the economy 

as a whole has increased by about 50 percent during the same period. Government continues to try and shape outcomes, but it does 

so with a much more realistic sense of what it can achieve. Why 

does it have this more realistic sense? Because when you look back 

on the record of the more intrusive Chinese industrial policy over 

the last 15 years, you can go back to the programmatic documents 

that the Chinese government produced, rather like what Dean 

Cowhey was saying in terms of planning in major corporations in 

the U.S. before the Internet. 

And you can see that their targets, their selected firms, their national champions—not one of them is an important success story 

that’s a significant rival to us today. There are other Chinese firms 

that are significant on the horizon, important and potentially might 

pose competitive challenges, but those are not the ones that the 

Chinese government was nurturing and building. So recognizing 

that, the Chinese government has backed down significantly. One 

last number in terms of the domestic side. China trades both in 

this externally oriented network and in trade for goods that come 

into the domestic marketplace directly. Chinese call that ordinary 

trade imports. Those ordinary trade imports have increased 30 percent per year since 1997. Relative to Chinese GDP, it imports into 

its own domestic market three times what it did six years ago. So 

WTO compliance is uneven. It’s raggedy. There are some real problems. But taking a step back, the long-term bottom line is that 

economy is considerably more open than it used to be. When we 

look at the external piece of the economy, what we see is a trade 

21 

that is dominated by global production networks. Global production 

networks are led in most cases that have relevance to our economy 

by U.S. firms. But there’s also a crucial intermediary, and that crucial intermediary is Taiwan firms. If you look at the personal computer industry, for instance, almost all of the new output coming 

out of China, the new exports, are produced through production 

chains where Taiwan-invested firms play a key role, but the overall 

stream of production is organized, is architected, in a way, by U.S. 

firms. Let me take an example. The hard disk drive industry. 

Here’s a classic industry that fits into the pattern that Dean 

Cowhey was talking about. 

20 years ago Japanese controlled the most sophisticated technology. Today U.S. firms dominate the industry. 

Seagate, a U.S. firm, produces hard disk drives in Wuxi, in China. It exported $1.2 billion worth of hard disk drives out of 

China. But it also imported from its neighbors in the rest of East 

Asia almost the exact same number, $1.2 billion worth of components that were assembled into China. 

The value added in China was less than 10 percent of the exported product. The value added in the United States that accrued 

to U.S. designers and engineers, we don’t know the exact numbers, 

but almost certainly more than 50 percent of that $1.2 billion. 

The fact that U.S. firms and Taiwan firms are the key actors in 

these global networks has a couple of direct implications for us. 

First, if we’re concerned about the transfer of technology to China 

because we’re concerned about the position of Taiwan, then we 

ought to—we must develop a strategy in combination with Taiwan 

firms because Taiwan firms are transferring much more technology 

to the China mainland than U.S. firms are. Take a look at semiconductors for a case study of this. 

The triangular relationship means that Taiwan has a huge sur- plus with China, $40 billion, while China has a huge surplus with 

the United States. The relationships are quite complex. 

Most importantly, the fact that these networks are organized by 

U.S. firms means three things. 

Number one, U.S. companies and workers earn significant 

amount of money from the product that comes out of China. 

Number two, U.S. consumers pay lower prices because these networks are extremely competitive, dynamic that bring goods quickly 

and cheaply out of China for the U.S. We can see this in the case 

of personal computers with Dell computers. The price of a new Dell 

computer for the local elementary school has dropped from $1200 

to $600 in the last year. Why? Because now they come out of China 

instead of out of Taiwan. And, finally, the fact that these networks 

are run by U.S. companies, just as Dean Cowhey pointed out, 

means that the low-cost production in China allows our standards, 

our products and our design platforms to prevail in an atmosphere 

of intense global competition. It’s not enough that our technologies 

be good. We also have to have a low-cost way to implement them 

in order to prevail against competing Japanese, European and even 

Chinese standards. And thus far, this connection between the U.S., 

Taiwan and China has served to do exactly that. 

Thank you. 

[The statement follows:] 

22 

Prepared Statement of Barry Naughton, Ph.D., Professor of Economics 

Graduate School of International Relations and Pacific Studies 

University of California, San Diego 

China’s Economic Growth and Technology Development: International 

Linkages and Implications for the U.S. 

Rapid Growth and Technological Development 

As everyone knows, China is booming. Economic growth in 2003 hit 9.1%, despite 

a significant temporary slowdown in the second quarter due to the SARS epidemic. 

Production of passenger cars shot past 2 million units last year, 80% more than the 

year before. Exports grew 34.6%, but imports grew even faster, increasing 39.9%, 

and China emerged as the fourth largest trading nation in the world. Seen for years 

as a place of enormous economic potential, China is beginning to realize its potential. 

The magnitude of change is especially striking in high tech industry, particularly 

electronics manufacturing. Some time during 2001, China emerged as the clear location of choice for new production and assembly operations by global electronics companies. Following a surge of investment, China’s exports of computers and peripherals increased by 54% in 2002, and then doubled in 2003, reaching $40 billion. Exports of electronics components, telecom equipment, and TV/AV equipment have 

doubled in two years, from 2001 to 2003, and surpass $35 billion for the three categories together. The center of gravity of the global electronics assembly industry 

is moving to China. 

China’s domestic market has now grown to be large, on a global scale, for a number of high tech products: telecommunications equipment (infrastructure and 

handsets), consumer electronics (especially television and video), and personal computers. The confluence of these big downstream markets has created huge demand 

for upstream products, including integrated circuits, display panels, and other high 

technology components. The vast majority of these items are still supplied by imports, but China has witnessed, since 2001, the birth of a handful of modern semiconductor firms that are only about two years behind the international technological 

frontier. Even highly sophisticated industries like chip design have made a small 

but significant start in China. 

China’s rapid growth and dramatic technologic trajectory pose challenges to the 

United States. Like any economic relationship mediated through the market, the relationship has elements of competition and rivalry, as well as cooperation. However, 

it is a mistake to view the relationship solely or primarily in terms of rivalry. Rather, rapid Chinese technological development has come in the framework of international production networks that are predominantly coordinated by U.S. companies. Chinese firms fit into production, design and supply chains that are orchestrated by U.S. companies. These relationships work strongly to the advantage of 

U.S. companies and consumers. In the remainder of this testimony, I will put China’s trade and technological relations in a broad context in order to highlight a few 

key features. 

A Triangular Relationship 

First: Taiwan is the key intermediary between the U.S. and China in high-technology industry. It is simply impossible to speak about high-tech industry in China 

without bringing high-tech industry in Taiwan to the forefront of the analysis. Taiwan has tremendous technological resources. It has a higher degree of dependence 

on electronics manufacturing and export than any other economy in the world. Taiwan is also the second-biggest investor in China, after Hong Kong. It is a much 

larger investor than either the U.S. or Japan. Moreover, in a big change from the 

early years when much of Taiwan’s mainland investment was in light labor-intensive manufactures—such as shoes, garments, and sporting goods—for the past five 

years, Taiwan’s investment has been overwhelmingly concentrated in electronics-related enterprises. 

In 2002, the most recent year for which we have official Chinese data, Taiwan 

investment apparently made up 8% of incoming FDI in China. But FDI from tax 

havens including the Virgin Islands, Cayman Islands, and Western Samoa accounted for twice as much (16%) of incoming FDI, and it is known that the majority 

of this investment comes from Taiwan. Even if only half of tax haven investment 

were from Taiwan (a highly conservative assumption to allow some Hong Kong investment), then Taiwan accounts for 16% of total FDI, second to Hong Kong’s 35%, 

and far ahead of number three U.S. (at 10%), or Japan (8%), and the EU–15 (7%). 

Data for 2003 are not available yet, but a preliminary ranking of the top ten investors has been published, and it shows continued growth of tax haven investment, 

23 

with Western Samoa rising rapidly in popularity. Thus, the Taiwan share has almost certainly increased further. In addition, both Korea and Japan significantly increased their FDI in China in 2003, and moved ahead of the U.S. for the first time 

since 1997 (in the case of Japan) or ever (in the case of Korea). 

Second: Taiwan firms, and now increasingly China firms, have been involved in 

a long-running partnership with U.S. firms. This partnership has been extremely 

beneficial to all sides. Initially with Taiwan and Singapore, but now increasingly 

centered in China, these partnerships have been crucial to the remarkable technological dynamism that the U.S. has displayed in the past ten years. In general 

terms, U.S. firms managed to create a division of labor in which U.S. firms concentrated on research and development, but also on the creation of new products 

and new technological standards, while portions of the manufacturing were carried 

out in various places in the ‘‘China Circle,’’ or greater China. Whether the technology was the Internet, or the defining standards of the personal computer—the 

Intel processor and the Microsoft Windows operating system—U.S. companies set 

the standards. However, the ability of U.S. companies to actually set the standards 

depended on their ability to also produce the systems for a price that could earn 

consumer acceptance. Standards were not just mandated by powerful corporations: 

they had to win acceptance in an intensely competitive world market. And win acceptance they did, frequently to the disadvantage of firms in Japan or Europe. 

This process was clearly at work in three key sectors: microprocessors, computers, 

and hard disk drives. In all three of these areas, U.S. firms faced vigorous competition from Japanese firms in the 1980s. By the mid-1990s, in each of these cases, 

U.S. firms had turned back the Japanese firms, and had established their systems 

as clearly predominant in the world market. It was not a simple matter of technological superiority. In many of the most relevant fields (such as magnetic storage 

capacity), Japanese technology was equal, or superior, to U.S. technology. Rather, 

U.S. firms prevailed by creating open, ‘‘modular’’ production networks that delivered 

lower costs and much faster time to market than Japanese firms were able to provide. Open technological systems in which any producer could ‘‘plug in’’ to the completed product, so long as he conformed to the dominant technological standard, 

proved to be superior from a cost standpoint. This permitted production chains to 

become vertically dis-integrated, allowing individual firms to specialize in the specific link of production in which they could be most efficient. The producers who 

emerged to fill this role were overwhelmingly located in the broader Chinese region. 

Sometimes these were U.S. firm subsidiaries or joint ventures, and sometimes they 

were indigenous firms in Taiwan, Hong Kong, or Singapore. China region firms developed substantial technological and manufacturing capacities in partnership with 

U.S. firms. In turn, they provided the low-cost manufacturing that enabled U.S.- 

based design standards and products to prevail. 

During the mid-1990s this model was simply pushed one step further onto the 

China mainland. As producers in Taiwan and Singapore moved up market, to more 

sophisticated components, they increasingly moved labor-intensive final assembly 

stages to the China mainland. There, they replicated the patterns which they themselves had pioneered in partnership with U.S. firms. Producing sometimes through 

their own subsidiaries, and sometimes by subcontracting to indigenous firms, they 

began to build electronics industry clusters on the mainland, initially specializing 

in final assembly. This system has had three important corollaries: 

1. China is a lot less high tech than it looks. Most Chinese ‘‘high tech’’ exports 

have actually just been assembly jobs, putting together high-tech components, 

brought in from the rest of Asia. 

2. Trade fit into a triangular pattern. China imported enormous quantities of 

components and sub-assemblies, and then exported finished products, primarily to the U.S. 

3. China established a whole system of ‘‘processing trade’’ (discussed in detail in 

Professor Hanson’s testimony) to allow imported inputs to enter the country 

easily and without tax, so long as they were promptly assembled and re-exported. This part of the Chinese economy was low tax and free of government 

interference, even when the government was trying to steer the rest of the 

economy. It grew up under the predominant influence of U.S. and Taiwan 

firms and investors. 

In the last few years, some important changes have meant that this simple picture is no longer quite so simple. The export system is no longer as completely separated from the domestic market as before, and the traditional triangular trade is 

rapidly upgrading. Nonetheless, the fundamental framework is intact. 

24 

Opening The Domestic Market 

In the earlier stage of China’s export development, the export economy was quite 

separate from the domestic economy, which was protected by trade barriers and 

subject to pervasive government attempts to steer economic and technological development. With China’s entry into the World Trade Organization (WTO), this is now 

beginning to change. While China’s implementation of WTO commitments has been 

uneven, and frustratingly slow in some areas, the bottom line is that WTO entry 

really is transforming the Chinese economy and making it much more open. We can 

see this by examining trade statistics for ‘‘Ordinary Trade’’ imports: that is, goods 

imported for the Chinese domestic market, not involved in any export-processing regime. Even as overall trade and imports have grown rapidly, Ordinary Trade imports have grown much more rapidly, and have sharply increased their share of 

total imports. Ordinary trade imports in 1997 were only 27% of total imports, and 

only 4.3% of GDP. By 2003, this figure has soared to 46% of total imports, and a 

remarkable 13% of GDP. Ordinary Trade imports have grown 30% per year since 

1997 (including a 46% jump in 2003). U.S. companies that used to produce in China 

only for export are now beginning to develop mixed strategies that target the Chinese market as well. As China opens its domestic distribution networks this year 

and next year, those strategies will become increasingly powerful. (For example, 

Dell Computer, which is already gaining market share in China’s domestic market, 

will adapt a range of new sales initiatives.) 

Moreover, there has been a dramatic shift in the Chinese government’s effort to 

shape China’s technological trajectory. To be sure, the Chinese government is still 

aggressively interventionist, and tries very hard to foster national technological capabilities. But the old-style industrial policy, picking ‘‘national champions’’ and 

propping them up with loans and preferential policies, or forcing foreign firms to 

partner with domestic firms and transfer key elements of their technology—these 

policies are largely finished. They have been discarded by the Chinese government 

because they simply didn’t work. Instead, the Chinese government now seeks to foster key domestic industries across the board, providing the same privileges to big 

and small firms and (more crucially) to domestic and foreign firms alike. The government promotes technological standards that it believes will give a competitive 

advantage to domestic firms. These policies are still sometimes intrusive and controversial, and occasionally push the boundaries of what is permissible. They are 

also policies premised on the belief that the most the government can do is temporarily influence market conditions, and if it acts skillfully, contribute to long-term 

development by providing temporary advantage to local firms. 

Much more important is the investment in physical infrastructure and education 

the government provides. China’s technological successes would be inconceivable 

without both. For example, the new network of limited access highways, now second 

only to the U.S. in length; and the fiber optic telecom backbone network, are both 

essential to economic progress. Even more important, a sustained effort in tertiary 

education has brought the proportion of China’s work force with some college education (about half in 3-year technical schools) from a sorry 0.9% in 1982, to a respectable 4.7% in 2000 (But compare the 52% in the U.S.). The Chinese government’s ability to sustain this investment effort has been far more important than 

the hit-and-miss fragments of ‘‘industrial policy,’’ even in its most recent, relatively 

sophisticated, version. 

A More Complex Triangular Relationship 

The recent surge in China’s technological development has been accompanied by 

a transformation of economic interactions beyond the simplest version of the triangular model. Originally, there were certain links in the production chain that 

were simply too technically sophisticated to be replicated in China, and the only activities in which China participated were the less sophisticated stages of global production chains. That has changed. But before we examine the differences, let’s look 

at the continuities: 

First, China’s high tech exports still come predominantly from a few coastal clusters where foreign investment is concentrated. More than 80% of China’s ‘‘high tech’’ 

exports in 2003 came either from Guangdong or from the Lower Yangtze (greater 

Shanghai) region. Well over half the total comes from five industrial clusters in 

Dongguan, Shenzhen, Suzhou, Kunshan, or Shanghai. Each of these clusters has 

lots of foreign investment, and a strong Taiwan presence. The producers are either 

foreign firms or closely linked subcontractors qualified by the foreign firms. Foreign 

firms continue to increase the share of China’s exports they produce, reaching 55% 

in 2003. 

Second, the triangular pattern of trade and deficits persists. China has a huge 

surplus with the U.S., but deficits with its East Asian neighbors that are almost 

25 

as large. The $120 billion deficit with Chinese that the U.S. projects for 2003 is part 

of a network that also produces Chinese deficits of $40 billion with Taiwan, a $24 

billion deficit with Korea, a $15 billion deficit with Japan, and deficits of $8 billion 

and $5 billion with Malaysia and Thailand respectively. Most of the deficit with China’s neighbors consists of semi finished goods or components. Overall, China runs 

a modest surplus (1.8% of GDP). 

However, China’s participation in these networks is no longer as predictable as 

before, and is not entirely confined to the final assembly stage. For example, China 

has begun to manufacture integrated circuits that are not far behind the world leading edge. These are the offshoot of the integrated circuit fabrication industry in Taiwan that caught up with the world technological frontier around 1995. The individuals now starting ‘‘trailing edge’’ IC factories (‘‘fabs’’ or ‘‘foundries’’) in China gained 

their experience in Taiwan firms, and before that in U.S. firms. The outstanding example is Richard Chang (Zhang Rujing), head of Semiconductor Manufacturing 

International Corporation (SMIC), based in Shanghai. Literally thousands of engineers and managers have come from Taiwan to China to launch this industry. SMIC 

is now mass-producing chips at .18 micron, while Intel’s new Prescott processor, released February 2, uses .09 microns. Thus, the gap between SMIC and Intel has 

shrunk to slightly less than 2 generations of chips. In related fashion, China—again 

following Taiwan—has begun to develop significant chip design facilities, with substantial government money going into training and research institutes. However, 

overall chip design capabilities are still rudimentary, and value of sales is limited: 

about U.S. $200 million in 2002. 

With China moving up the value chain into more sophisticated activities, and 

with output and exports exploding, is the old model obsolete? In fact, the underlying 

structure of the old model remains intact, while the networks undergo continuous 

rapid upgrading. The result is an increasingly detailed and increasingly complex division of labor. Certain skills that were once scarce, are gradually diffusing, and 

China has taken advantage of this trend, and is in turn a major beneficiary. The 

ability to manufacture sophisticated ICs is becoming much more widespread. East 

Asia (outside Japan but including China) has dramatically increased its share of 

global production, and the European industry has also revived. But while IC fabrication skills have diffused, the sophistication and complexity of the entire value 

chain—including design, fabrication, and integration into final uses—has continuously increased. As the chips themselves have developed much more capacity and 

are much cheaper (following Moore’s Law), other parts of the value chain, such as 

chip design, loom larger in the overall cost structure. Moreover, downstream uses 

for the chips diversify away from the formerly dominant personal computer, to include all kinds of new applications: new wireless products and digital video products, especially. These diverse end products imply even greater demands on the design process, particularly with the advent of complex ‘‘system on a chip’’ (SOC) products. Therefore, designers have been forced to de-construct the design process, 

breaking it down into discrete steps, creating re-usable modules, and ‘‘mechanizing’’ 

some activities, in a way that echoes what happened to the hardware production 

process beginning thirty years ago. Stages of the design network are relocating to 

Asia (first Taiwan, then China) as well. 

In this process, production and design networks are becoming so much more complex that they can no longer be reduced to any simple, uniform characteristic. Nor 

can China’s participation be pigeon-holed as it could earlier. But we can ask: Are 

these changes overturning the kinds of relationships that existed earlier, or are they 

extending them? The answer is clearly that these are evolutionary changes that are 

highly consistent with the pre-existing relationship among firms in the U.S., Taiwan, and China. In the case of IC design, for example, specialized design firms provide the most sophisticated design services, and also produce the design ‘‘building 

blocks’’ that must be integrated into a specific chip design. In order to tie together 

various processes efficiently, leading multinational corporations attempt to develop 

‘‘platform leadership’’ strategies in which they make decisions about the overall system architecture, the interfaces among different parts of the design, and the degree 

of intellectual property protection they seek to maintain. In both these stages, U.S. 

firms play a predominant role. Specialized global suppliers of design building blocks 

are predominantly U.S. (indeed, California) firms, including MIPS, Rambus, and 

DSP. ‘‘Platform leadership’’ is exerted by large multinationals like Cisco, Dell, or 

Intel. These ‘‘Global flagships’’ preside over both global production and global design 

networks. Firms in China, and in Taiwan (which still overshadows Chinese firms 

in design capabilities) are integrated into this overall system. Because design building blocks are still a long way from fully codifiable ‘‘plug and play’’ elements, ongoing technical assistance and sharing is required, and firms stress long-term cooperative relations with their design and manufacturing partners. 

26 

American Firms Are Architects of Global Networks That Incorporate China 

American firms, in other words, still play crucial roles as the architects of global 

design and production networks. U.S. firms manage these networks so that, whenever possible, there are multiple suppliers in China. The high-tech clusters—such 

as the five clusters that account for more than half the hi-tech exports—generally 

have multiple suppliers in close proximity competing for similar business. The network architects maintain a degree of competitive pressure, even as they build longterm cooperative relations with their most reliable, and highest quality suppliers. 

Taiwan intermediaries often cooperate in maintaining this intense cost pressure on 

suppliers. 

Indeed, this kind of structure is common in U.S. trade relations with China, even 

outside the high-tech sector. Companies that bring in running shoes, toys, or garments nearly always maintaining contractual ties with a number of local suppliers. 

Moreover, enormous changes—and significant productivity gains—have taken place 

in American retailing and distribution in the past twenty years due to the sustained 

focus on reducing inventory. A single-minded focus on reducing inventory has led 

American retailers to insist that suppliers produce smaller batches, deliver goods 

more quickly, and demonstrate greater flexibility to respond to constantly changing 

demand. Where have U.S. retailers found suppliers willing and able to do this? In 

China, of course, with the relationship again mediated by Taiwan and Hong Kong 

businesses. It is not an accident that the American retailer with the most sophisticated inventory management techniques, Walmart, is also the largest importer of 

goods from China ($12 billion last year). 

These production networks, and the American position in them are strongly beneficial to the U.S., in three respects: 

(a) U.S. corporations, controlling the design, supply, and marketing channels, 

earn the bulk of the revenue from sales in the U.S. of goods produced by them 

in China. For example, Seagate’s Wuxi factory exported $1.22 billion worth of 

hard disk drives in 2002, predominantly to the U.S. However, this one factory 

also imported $1.27 billion worth of components in that year. Value-added in 

China was a small percentage of the value of the goods imported by the U.S., 

certainly less than 10% of the total. More crucially, a rough calculation indicates that over 50% of the value of those goods accrued to U.S. citizens, either 

as wages in design, research, or marketing; or as profits. (Another 30–40% accrues to residents of other Asian countries who produce components assembled 

in China.) 

(b) U.S. consumers pay much less for goods. For example, the fact that American 

students and schools can now buy an excellent Dell Computer desktop for 

about $500 is the result both of technological progress and the transplanting 

of Dell’s formerly Taiwan-based networks to the mainland. 

(c) Potentially most important: the partnership of U.S. corporations and Chinabased factories has enabled the success of U.S. research and corporate strategies. In a world marked by globalization and intensifying competition worldwide, the remarkable successes enjoyed by U.S. corporations—and the U.S. 

economy—in the past ten years have been by no means fore-ordained. The 

U.S. has increased its economic weight among the OECD (developed) countries, and increased its technological importance as well. The fact that it has 

been able to do so is of course primarily due to U.S. domestic factors, but the 

partnership between the U.S. and China region producers has been a key enabling factor. China production has allowed U.S. producers to implement lowcost solutions that have led to the competitive success of their strategies, products, and standards. The networks that enable that kind of success are becoming even more complex, and more inter-dependent, and their contribution to 

U.S. technological and competitive capabilities are probably increasing. 

Conclusion 

The major economy that has lost relative position in the global economy in the 

1990s was Japan. A major contributing factor was Japan’s historic crisis and its relative withdrawal from Asia and the world (Japan’s share of global trade and outgoing FDI declined substantially during the 1990s.) That is exactly the point: Preoccupied with its own problems, Japan did not take advantage of the opportunities 

on which U.S. firms seized. They missed the opportunity to restructure their production networks, bring Asia and China closer into the production chain, and push 

down their own production costs. Recently, Japan has re-assessed its position. Restructuring in Japan—particularly in the electronics industry—has accelerated. Investment in China has surged, and surpassed U.S. investment last year for the first 

time since it fell behind. At this juncture, exactly what the U.S. should NOT do is 

27 

to emulate what Japan did in the 1990s. According to Ernst (2003), the Japanese 

tried ‘‘to retain an unequal division of labor that ke[pt] the development and production of leading-edge and high value-added products and production stages in Japan. 

They also tr[ied] to minimize possible leakages of technological knowledge. But their 

capacity to sustain this flying geese pattern of specialization [was] gradually eroded 

by intensifying competition both from above and below’’ It would be particularly 

ironic if we launched onto this failed path just as Japan, coming out of a lost decade, 

was committing itself to a renewed involvement in China and Asia. 

REFERENCES 

Chinese trade and investment data from the Ministry of Commerce at 

www.mofcom.gov.cn/, U.S. data from Department of Commerce Bureau of Economic 

Analysis at www.bea.gov/bea/international/. Deficits calculated from importing 

country statistics. Estimated size of China’s IC design industry from Mike 

Clendenin, ‘‘Link by link, China crafts its industry,’’ EE Times, December 8, 2003. 

Ernst, Dieter (2004) ‘‘Internationalisation of Innovation: Why is Chip Design Moving to Asia?’’ Honolulu: East-West Center Economics Working Paper #62; forthcoming in International Journal of Innovation Management. 

Ernst, Dieter (2003), ‘‘A Contrarian Force in Asian Regionalization? Transformations of Japanese Production Networks in the Electronics Industry,’’ in 

Katzenstein, P.J. and Takashi Shiraishi (eds), Remaking Asia: Beyond Americanization and Japanization, Ithaca: Cornell University Press. 

Howell, Thomas et al. China’s Emerging Semiconductor Industry. Washington, 

D.C.: Dewey Ballantine LLP, for Semiconductor Industry Association, October 2003. 

Naughton, Barry, 1996, ‘‘China’s Emergence and Prospects as a Trading Nation,’’ 

Brookings Papers on Economic Activity, 2: 1996, pp. 273–343. 

Naughton, Barry and Adam Segal, ‘‘Technology Development in the New Millennium: China in Search of a Workable Model,’’ in William Keller and Richard Samuels, eds., Crisis and Innovation: Asian Technology After the Millennium. New York: 

Cambridge University Press, 2002. Pp. 160–186. 

Vice Chairman D’AMATO. Thank you very much, Dr. Naughton. 

We’re going to move up the coast now. We have been spending 

our time in San Diego. Dr. Fung is from Santa Cruz, University of 

California. 

STATEMENT OF K.C. FUNG, Ph.D. 

PROFESSOR OF ECONOMICS 

UNIVERSITY OF CALIFORNIA, SANTA CRUZ 

Dr. FUNG. Thank you. 

I appreciate the opportunity to speak in front of you. It’s an 

honor to provide some statements for this hearing. First, I would 

like to update, and as a matter of providing some background, 

some of the features that—implications for the U.S.-China relationship concerning China’s trade and foreign direct investment. And 

in particular there’s six aspects I just want to quickly highlight. 

One is that increasingly China’s trade is more and more conducted 

by foreign invested enterprises. 

For example, in 2003 more than half of China’s exports are now 

conducted by foreign firms. What that implies for foreign and U.S. 

multinational firms is that there is a great opportunity for them to 

participate in the explosive growth of China’s trade. For example, 

the rate of return for U.S. multinationals in 2002, according to U.S. 

statistics in computer and electronic products, would be estimated 

to be more than 20 percent. Secondly, more and more of China’s 

trade, even though it’s still large, is now shipped more directly, bypassing Hong Kong even though reexports through Hong Kong in 

2003 still exceeds 25 percent. 

Thirdly, China’s trade in foreign direct investments are still very 

geographically concentrated even though Guangdong’s share of ChiVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00033 Fmt 6633 Sfmt 6602 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
28 

na’s exports still account for about 35 percent in 2003. It is increasingly losing its share to Shanghai. 

Fourth, much of China’s trade is really, as Dr. Barry Naughton 

testified, related to processing and assembly. In 2003 more than 

half of China’s exports are processed exports. What that implies is 

the domestic value added generated by Chinese exports to the 

United States would be relatively low. 

One study put the estimate of domestic value added at about 19 

cents for each dollar. Fifth, there is, according to official statistics, 

increasing amount of Chinese exports of high-tech products. More 

than a quarter of Chinese exports are now classified as high tech, 

even though it’s very difficult to find out exactly how they come up 

with different classifications of high tech. Sixth, and lastly, more 

and more of the foreign direct investment in China are not joint 

ventures; they’re wholly foreign owned. Almost 70 percent of foreign direct investments take the form of wholly foreign-owned enterprises. And, of course, except for Virgin Islands, the United 

States is the second-largest direct investor in China in 2002. 

Next, I want to move on to the economic roles of China in the 

Asia-Pacific region. As pointed out several times by Professor Barry 

Naughton, as well as Dean Cowhey, there are really two aspects 

of China in the eyes of foreign multinationals. And that’s somewhat 

unusual for a developing economy that these two aspects go hand 

in hand together. 

That is, one, at the same time it is a large and growing market 

with a domestic large market for affiliate sales. And, second, it is 

also a low-cost center of manufacturing. First, for the large and 

growing market aspects, from different sources, U.S. and Japanese—their investment in China are aiming much more at the domestic market compared to other sources of direct investment, such 

as those from Hong Kong and Taiwan. 

Surveys from the Japanese government also highlighted that 

Japanese multinationals would sell almost half of the products in 

China. In general, the rate of return, given the improvement in the 

business climate in China for U.S. direct investment in general is 

estimated to be about 14 percent, higher for computer and electronic products. 

In terms of China being a low-wage production site, Hong Kong 

and Taiwanese multinationals are a lot more responsive to low 

wages compared to U.S. and Japanese. Both Japanese and U.S. 

companies seems to place a heavier emphasis on skilled labor in 

the Chinese market compared to Hong Kong and Taiwanese companies. 

Again, the Japanese government survey pointed out that Japanese multinationals locate in China first because of low wage reason and, second, because of the domestic market reason. Next I 

want to move on to the effects of China on the United States and 

its neighbors. Now, the aspect of China being a large market, by 

and large, is obviously a positive for most of its neighbors, as well 

as for the U.S. However, if you view the U.S. as a low-wage export 

platform, is there a case or scenario whereby multinationals would 

choose to invest in China instead of other locations, such as Malaysia? 

29 

One study—two recent studies pointed out that, at least for the 

data we have from 1985 to 2001, the levels of foreign direct investment in China seem to be going hand in hand and complementary 

to foreign direct investment in other Asian economies such as Taiwan, Singapore, Korea, Thailand, Malaysia, Philippines and Indonesia. 

However, it does reduce the shares of foreign direct investment 

in those economies as a proportion of all the direct investment into 

Asia and also as a proportion to all the direct investment to all developing economies. 

So, so far, the levels are complementary, the amount are complementary, but the shares are going in the opposite direction with 

China gaining a larger share compared to these economies. The 

fact that the levels of foreign direct investment in China are complementary are consistent with what Professor Barry Naughton, as 

well as Dean Cowhey, described as the production sharing, or 

China being an important link in the global supply chain. 

So while you might invest in the production of hard disk drives 

in China, but at the same time you would want to invest in Korea 

to produce liquid crystal displays. And they would exchange these 

components and parts. And estimation about domestic value added 

from such participation of the global supply chain in the area of 

high tech, such as electric machinery and instrument, as well as 

electronic and communication equipment, it tends to be still relatively modest. One dollar of Chinese exports of these high-tech 

items would generate about 14 cents for China in terms of domestic 

value added. Now, the future, of course, may look different, but 

that’s the existing study. Just to conclude quickly, just three remarks. One is that China’s development strategy so far seems to 

look very different from the development strategy pursued by 

Japan or Korea. These two economies from the outset actively preclude foreign direct investment, whereas, China from the outset actively encouraged foreign direct investment. 

So in that regard, multinationals have a greater chance to participate in China’s growth compared to the Japanese growth experience. Secondly, the stock of U.S. direct investment in China is really still relatively small. By 2002 less than 1 percent of the stock 

of U.S. direct investment in the world was really in China. 

The bulk of it, of course, as we know, foreign direct investment 

from the U.S. is primarily to other rich industrialized countries. 

Now, in the 1960s and the ’70s when several European countries 

embarked on their European integration, it was often feared by 

both academics, as well as policymakers, that there would be a 

wholesale restructuring of industries of these European economies, 

such as Italy losing the entire auto sector to Germany; but it turns 

out not to be entirely correct. What happened was a slice of the 

auto industry would be lost from Italy to Germany so that Germany would import Italian sports car by the same time Italy would 

import German luxury cars. 

It seems that this is happening with the case of China’s integration in the global economy except through intermediate goods. 

There is now specialization on components and parts. And these 

economies, particularly in Asia, are now exchanging both import 

and export to each other, these components and parts. For the 

30 

United States, clearly for the low-cost industries, such as apparel, 

furniture and so on, there has been and there will be great dislocations. But at the same time, for some industries, such as high tech, 

I think the business model of global supply chain, as well as the 

two-way trade of components and parts, would make it a lot easier 

for the sector to adjust. 

Vice Chairman D’AMATO. Thank you very much. Why don’t you 

go ahead and finish up, and we’ll go—move on. 

Dr. FUNG. Thank you. 

Finally, just to say that the Chinese global—growing market also 

would represent concrete benefits to American multinationals. 

Thank you. 

[The statement follows:] 

Prepared Statement of K.C. Fung 

Professor of Economics, University of California, Santa Cruz 

Trade and Investment: China, the United States, and the Asia-Pacific 

Economies 

1. Characteristics of China’s Trade and Foreign Direct Investment 

China’s open door policy has been an economic as well as a political success (Shirk 

1994). China’s trade and direct investment have some interesting characteristics. In 

this introductory section, I will first describe some of these stylized features. In particular, I would like to highlight six aspects. 

First, a substantial amount of China’s trade is conducted by foreign-invested enterprises. In 2003, foreign firms conducted 56.2% of China’s imports and 54.8% of 

China’s exports. To a very large extent, China’s trade is quite heavily dependent on 

enterprises from other economies (Naughton, 1996, Fung 1998). Because of the involvement of foreign-invested enterprises in China’s exports, this implies that foreign firms, including U.S. firms do directly benefit from the explosive growth of China’s trade with the rest of the world. In 2002, the rate of return for U.S. multinationals in computer and electronic products can be estimated to be 21.2%. 

Second, a large amount of China’s trade is first shipped to Hong Kong and then 

re-exported (Feenstra and Hanson 2004, Fung 1998). In 2003, 28.3% of Chinese exports to the world was re-exported via Hong Kong, while 21.9% of Chinese imports 

from the world was first sent to Hong Kong before re-exported into China. The large 

extent of re-exports is quite unique to China’s trade. One business implication of 

the importance of re-exports in China’s trade is that in evaluating the export market potential of China, one will need to take re-exports into account. A policy and 

a research implication is that the bilateral trade data of most countries with China 

need to be adjusted, including those of the United States, Japan, the European 

Union and Canada (Feenstra, Hai, Woo and Yao 1999). Using adjusted official U.S. 

data, the adjusted estimate of United States-China bilateral trade balance for 2002 

is $76.6 billions (Fung and Lau 2003). 

Third, China’s trade and foreign direct investments are geographically concentrated. In 2003, Guangdong’s imports accounted for 31.7% of China’s total imports, while Gunagdong’s exports accounted for 34.9% of China’s total exports. Most 

of China’s foreign direct investments still flow to the east and coastal areas. In 

2002, the east and southeast coastal areas (Shanghai, Jiangsu, Zhejiang, Fujian, 

Shandong, Guangdong, Hainan, Beijing, Tianjin, Hebei, Liaoning and Guangxi) received 89.5% of all realized foreign direct investments. 

Fourth, a large percentage of China’s trade is related to processing and assembly. 

In 2003, 55.2% of China’s exports are processed exports, while 39.5% of China’s imports are processed imports. Typically processed exports have lower domestic valueadded than non-processed exports. On average, the domestic value-added of Chinese 

exports is still relatively modest. In 1995, $1 worth of aggregate Chinese export to 

the United States induces a direct domestic value-added of $0.19 (Chen, Cheng, 

Fung and Lau 2001). 

Fifth, according to China’s Custom Statistics, in 2003, China exported $110.3 billion (25.2% of China’s total exports) of high-technology products. It also imported 

$119.3 billion (28.9% of total imports) of high-technology goods. However, it is not 

entirely clear how these figures are calculated from the various classifications in the 

trade data. At any event, two-way trade of high-technology goods seems to be substantial. This partly reflects the fact that in certain industries, China is now a part 

31 

of the global supply chain network and thus it engage in both importing and exporting of various components and parts (Roach 2003, Rauch 2001). 

Sixth, most recent foreign direct investments in China are not joint ventures. Instead, they take the form of wholly foreign-owned enterprises. In 2002, 69.2% of contracted foreign direct investments were wholly foreign-owned. In 2002, excluding the 

Virgin Islands, the United States is the second largest direct investor in China. 

There is no particular reason to expect that U.S. investments in China to have different modes of ownership that differ significantly from the general pattern. This 

implies that U.S. multinationals will increasingly have greater controls of their operations in China. 

2. Economic Roles of China in the Asia-Pacific Region 

China plays several important economic roles for its neighbors and to foreign and 

U.S. multinationals. Typically developing economies attract U.S. and other multinationals because of their low wages. Industrialized economies such as the United 

States and the European Union, on the other hand, attract foreign direct investment 

because of their large market sizes. For the case of China, these twin aspects—a 

large and growing market and a low-cost but high-quality labor force—come together. Thus U.S. and Asian firms are attracted to China because of its dynamic, 

large and rapidly growing economy as well as its cheap labor. 

2.1. China as a large and growing market 

Existing economic studies support the view that the domestic market of China is 

an important determinant of foreign direct investment in China (Cheng and Kwan 

2000, Fung, Iizaka and Parker 2002, Fung, Iizaka, Lin and Siu 2002). Furthermore, 

multinationals of different countries place somewhat different degrees of emphasis 

on the importance of the domestic market of China. U.S. and Japanese direct investments tend to be more responsive to a larger market in China than firms are from 

Hong Kong and Taiwan (Table 1). For example, a one-percent increase in the provincial gross domestic product (GDP) will induce an increase of 0.76% of U.S. direct 

investment, but only 0.40% of Hong Kong investment. 

Several surveys also show that multinationals sell significant shares of their products produced in China in the local Chinese market. According to the Ministry of 

Economy, Trade and Industry (METI) of the Japanese government, in 2001, Japanese affiliates in China and Hong Kong sold 47.2% of the products locally. According 

to a survey done by Chung Hua Institution of Economic Research in Taiwan, U.S. 

multinationals sold more than 80% of their products produced in China locally 

(Fung, Lau and Lee 2004). Finally in the area of high-technology, according to reports from the American Electronics Association, China is now already the third 

largest information technology market in the world. China is also the third largest 

semiconductor market in the world, behind only the United States and Japan. It is 

often reported that China is not an easy place to do business, but it seems that the 

U.S. multinationals are increasingly benefiting from the booming domestic Chinese 

market. In general, the rate of return for U.S. direct investments in China in 2002 

is estimated to be 14.1%. 

2.2 China as a low-wage production site 

Economic studies also show that China’s low wage rates and its quality of labor 

are important determinants of foreign direct investments (Chen and Kwan 2000, 

Fung, Iizaka and Parker 2002, Fung, Iizaka, Lin and Siu 2002). Hong Kong firms 

are particularly lured by the lower Chinese wages. U.S. and Japanese direct investments do respond to the wage rates in China, but their responses are less pronounced compared to Hong Kong and Taiwanese multinationals. In contrast, Japanese and U.S. companies place more emphasis on the quality of labor than other 

Asian multinationals (Table 1). For example, a one-percent reduction in Chinese 

provincial wage rate will increase Taiwanese direct investment by 2.64% but will 

only increase U.S. direct investment by 1.79%. A one-percent improvement in the 

provincial Chinese quality of labor will raise Japanese direct investment by 1.29% 

but will only increase U.S. direct investment by 0.97%. 

A survey by the Japanese government also shows that cost consideration is the 

number one motive for Japanese multinationals to locate in China (Table 3). The 

same survey shows that expanding market shares in China and Hong Kong is the 

second most important motive for investing in China. Thus from both econometric 

studies as well as survey data, China is seen by multinationals as both a low-cost 

production site as well as a place where they can sell their products through their 

affiliates. 

32 

3. The Effects of China on the U.S. and Its Asian-Pacific Neighbors 

As a large and growing market, China increasing plays the role of a locomotive 

in the Asia-Pacific region. This aspect of China is demand-enhancing and investment augmenting. To the U.S. multinationals, the Chinese market represents a 

profitable opportunity (Table 4). Unlike the Japanese growth experience, China’s development strategy so far is one of relative inclusiveness. By welcoming foreign 

firms, it allows foreign companies to participate and to benefit from its rapid 

growth. 

As a site for low-cost manufacturing, China represents an opportunity for U.S. 

multinationals to cut their costs of productions. By cutting their costs, U.S. firms 

obviously will increase their global profits. However, if U.S. and other foreign multinational corporations view China mainly as a low-wage export platform, then they 

may consider investing in China instead of in other locations. This may reduce direct investments in other countries and reduce their economic welfare. 

Recent economic studies so far suggest that foreign direct investment in China is 

complementary to direct investments in other Asian-Pacific economies, including 

Hong Kong Taiwan, Singapore, Republic of Korea, Thailand, Malaysia, the Philippines and Indonesia. On average, a one-percent increase in foreign direct investment into China will raise direct investment into China’s neighboring economies by 

0.55%, even though it will reduce the shares of investments of these economies as 

a proportion of total Asian and developing countries’ direct investments by 0.23% 

and 0.19% respectively. Thus in terms of levels of foreign direct investment, the 

presence of China is investment augmenting, even though China does seem to reduce the shares of foreign direct investment of its regional neighbors. 

The fact that direct investment levels in China are complementary to direct investment levels in its neighbors is consistent with the view that China is not only 

viewed by foreign and U.S. multinationals as a low-wage export platform, but also 

as an important link in the global supply chain. In this business model, the value 

chain is sliced thinner and thinner and each stage of production is parceled out to 

a different specialized site to minimize global costs of production. 

In the immediate geographic vicinity of China, this network of production-sharing 

is especially pronounced among the three members of the China Circle (China, Hong 

Kong and Taiwan) and in certain industries such as technology goods and components (Naughton 1997, 2004, Roach 2003). Being an important site for global production-sharing, China will both import and export goods that belong to the same 

industry such as electrical equipment (Table 6). In 2003, China imported and exported significant amount of items in the category of electrical equipment to its 

neighbors. Except for Indonesia, exports and imports of goods, components and parts 

in the electrical equipment industry rank either as first or second in the trade of 

these economies with China. The two-way trade of many goods, including those 

within electrical equipment also raises the issue of how much domestic value added 

China derives from such trade. Existing studies seem to suggest that the domestic 

value-added generated by such types of Chinese exports is not exceptionally high, 

particularly for processed exports (Table 7). In the case of processed exports of electric machinery and instrument, the total domestic value-added generated amounted 

to an estimated 14.4%, while for processed exports of the manufacture of electronic 

and communication equipment, the corresponding estimated total domestic valueadded is 13.8%. In general, for processed and non-processed exports combined (aggregate exports), the domestic value-added generated tend to be higher. 

4. Concluding Remarks 

China’s trade and foreign direct investment have some distinctive characteristics. 

Some of these characteristics have business and policy implications for the United 

States. By allowing foreign firms to substantially participate in its external sector, 

China is often seen to be more open than many economies at similar stages of economic development. 

Unlike many developing and transition economies, China attracts many foreign 

multinationals because of both its large and booming domestic market as well as 

its cheap but high-quality labor. However, to many foreign firms in the high-technology sector, China is not only a cheap export platform, but it is also an important 

link in the global supply chain. 

It is important to put the presence of U.S. firms in China in perspectives. In 2002, 

less than 1% of the stock of U.S. direct investment in the world was in China. In 

2001, less than 4% of the employment of the non-bank majority-owned U.S. affiliates abroad was located in China. It will take a long time before China can come 

close to have the amount of U.S. direct investment and associated employment in 

countries like the United Kingdom or Canada. 

33 

In the 1960s and the 1970s, when several European countries embarked on the 

first stages of European economic integration, it was often feared that in some countries, whole industries or sectors would disappear. Later on this was proven to be 

inaccurate. A slice of an industry may move from Germany to Italy, but countries 

would specialize in niches of the same industry and trade with each other. For example, Italian sport cars are exported to Germany, while Germany luxury cars are 

exported to Italy. Most researchers now believe that due to such horizontal two-way 

trade, economic adjustments took place within industries and were not as large as 

first feared. 

For the case of China, a similar situation may occur. The economic integration 

of China into the world market system will increase global efficiency, but it will also 

cause dislocations and in some situations, large dislocations. However, countries in 

the Asia-Pacific will adapt to specialize in various stages of the global production 

process and expand their trade of differentiated components and parts with each 

other. For example, Korean liquid crystal displays may be exchanged with Chinese 

motherboards. The increased vertical two-way trade of intermediate goods between 

China and its neighbors will reduce their costs of economic adjustments. At the 

same time, China’s rapidly growing market represents concrete benefits to China’s 

Asian neighbors as well as to the United States. 

REFERENCES 

Busakorn Chantasasawat, K.C. Fung, Hitomi Iizaka and Alan Siu, 2003, ‘‘The 

Giant Sucking Sound: Is China Diverting Foreign Direct Investments from Other 

Asian Economies?’’ paper presented at the 6th Asian Economic Panel Meeting, 

Seoul, Oct 9–10, 2003, Asian Economic Papers, forthcoming. 

Busakorn Chantasasawat, K.C. Fung, Hitomi Iizaka and Alan Siu, 2003, ‘‘International Competition for Foreign Direct Investment: The Case of China,’’ paper presented at the Hitotsubashi University Conference on International Trade and FDI, 

December, 12–14, 2003. 

Chen, Xikang, Leonard Cheng, K.C. Fung and Lawrence J. Lau, 2001, ‘‘The Estimation of Domestic Value-Added and Employment Induced by Exports: An Application to Chinese Exports to the United States,’’ mimeo, University of California, 

Santa Cruz. 

Cheng, L. and Y. Kwan, 2000, ‘‘What are the Determinants of the Location of Foreign Direct Investment? The Chinese Experience,’’ Journal of International Economics, 51, 2, 379–400. 

Feenstra, R.C., Hai, W., Woo, W.T. and S. Yao, 1999, ‘‘Discrepancies in International Data: An Application to China-Hong Kong Entrepot Trade,’’ American Economic Review Papers and Proceedings, 89, 338–343. 

Feenstra, R.C. and Gordon Hanson, 2004, ‘‘Intermediaries in Entrepot Trade: 

Hong Kong Re-exports of Chinese Goods,’’ Journal of Economics and Management 

Strategy, forthcoming. 

Fung, K.C., 1998, ‘‘Accounting for Chinese Trade: Some National and Regional 

Considerations,’’ in R. Baldwin, R. Lipsey and J. David Richardson (ed.), Geography 

and Ownership as a Basis for Economic Accounting, NBER Conference Volume, University of Chicago Press. 

Fung, K.C., Hitomi Iizaka and Stephen Parker, 2002, ‘‘Determinants of U.S. and 

Japanese Direct Investment in China,’’ Journal of Comparative Economics, 30, 567– 

578. 

Fung, K.C., Hitomi Iizaka, Chelsea Lin and Alan Siu, 2002, ‘‘An Econometric Estimation of Locational Choices of Foreign Direct Investment: The Case of Hong Kong 

and U.S. Firms in China,’’ University of California and University of Hong Kong, 

mimeo. 

Fung, K.C., Hitomi Iizaka and Alan Siu, 2003, ‘‘Japanese Direct Investment in 

China,’’ China Economic Review, 14, 304–315. 

Fung, K.C. and Lawrence J. Lau, 2003, ‘‘Adjusted Estimates of United StatesChina Bilateral Trade Balances: 1995–2002,’’ Journal of Asian Economics, 14, 489– 

496. 

Fung, K.C., Lawrence J. Lau and Joseph Lee, 2004, ‘‘United States Direct Investment in China,’’ AEI Press: Washington, D.C., forthcoming. 

General Administration of Customs of the People’s Republic of China, China Customs Statistics Monthly, Hong Kong: Economic Information and Agency, various 

issues. 

Mataloni, Raymond, Jr., 2003, ‘‘U.S. Multinational Companies: Operations in 

2001,’’ Survey of Current Business, Bureau of Economic Analysis, Washignton, D.C.: 

The United States Government, November. 

34 

Ministry of Economy, Trade and Industry (METI), 2001, ‘‘Wagakuni Kigyou no 

Kaigai Jigyou Katsudou,’’ 29, Tokyo: The Government of Japan. 

Ministry of Economy, Trade and Industry (METI), 2002, ‘‘Wagakuni Kigyou no 

Kaigai Jigyou Katsudou,’’ 30, Tokyo: The Government of Japan. 

Naughton, B., 1996, ‘‘China’s Emergence and Prospects as a Trading Nation,’’ 

Brookings Papers as Economic Activity, 2, 273–344. 

Naughton, B., 1997, ‘‘The China Circle: Economics and Technology in the PRC, 

Taiwan and Hong Kong,’’ Brookings Institution: Washington, D.C. 

Naughton, B., 2004, ‘‘Testimony before the Hearing of U.S.-China Commission on 

Economics and Security’’, U.S.-China Commission, mimeo, University of California, 

San Diego. 

Rauch, J.E., 2001, ‘‘Business and Social Networks in International Trade,’’ Journal of Economic Literature 39, December, 1177–1203. 

Roach, S., 2003, ‘‘Getting China Right,’’ Morgan Stanley Special Economic Study, 

September. 

Shirk, Susan, 1994, ‘‘How China Opened Its Door: The Political Success of the 

PRC’s Foreign Trade and Investment Reforms,’’ Brookings Institution: Washington, 

D.C. 

Survey of Current Business, ‘‘U.S. Direct Investment Abroad: Detail for Historical-Cost Position and Related Capital and Income Flows, 2002,’’ Bureau of Economic Analysis, Washington, D.C.: The United States Government, September. 

Appendix 

Table 1. Determinants of Direct Investment in Different Provinces of 

China 

U.S. Direct 

Investment 

Japanese Direct 

Investment 

Hong Kong Direct Investment Taiwanese Direct 

Investment 

1% increase in 

Gross Domestic Product 

Increase by 

0.76% 

Increase by 

0.71% 

Increase by 

0.40% 

Increase by 

0.58% 

1% increase in 

the Wage Rate 

Decrease by 

1.79% 

Decrease by 

1.57% 

Decrease by 

2.66% 

Decrease by 

2.64% 

1% improvement 

in Labor Quality 

Increase by 

0.97% 

Increase by 

1.29% 

Increase by 

0.43% 

Insignificant 

Source: Fung, Iizaka and Parker (2002). 

Table 2. Destinations of Sales of Japanese Affiliates in 2001 

Locally 

(%) 

Exported 

to Japan 

(%) 

The 

Third 

Country 

(%) 

China and Hong Kong 47.2 31.5 21.3 

ASEAN4 38.8 28.1 33.0 

NIE3 59.1 17.7 23.2 

Asia 48.8 24.7 26.5 

World 70.0 10.9 19.1 

Source: METI (2002). 

NIE3 includes Taiwan, Singapore and Republic of Korea. 

ASEAN4 includes Thailand, Indonesia, Malaysia and the Philippines. 

Figures may not add to 100% due to rounding. 

Table 3. Motives behind Japanese Direct Investment, 1999 

Motive 

China 

and 

Hong 

Kong 

(%) 

ASEAN4 

(%) 

NIE3 

(%) 

World 

(%) 

Reasons related to lower costs 40.1 37.6 31.0 30.0 

35 

Table 3. Motives behind Japanese Direct Investment, 1999—Continued 

Motive 

China 

and 

Hong 

Kong 

(%) 

ASEAN4 

(%) 

NIE3 

(%) 

World 

(%) 

To expand their market shares in the country 20.9 19.4 24.1 24.3 

To re-export to Japan 8.9 6.7 5.7 5.8 

For research and development 0.7 0.1 1.0 1.8 

Source: Fung, Iizaka and Siu (2003), METI (2001). 

NIE3 includes Taiwan, Singapore and Republic of Korea. 

ASEAN4 includes Thailand, Indonesia, Malaysia and the Philippines. 

The answers are percentage of firms that pick that reason as their motives. 

To save space, other motives have been omitted. 

Table 5. The Effects of Foreign Direct Investment in China on Other 

Asian-Pacific Economies 

Levels of Foreign Direct Investment in 

China’s Neighbors 

Foreign Direct Investment in China’s 

Neighbors as Shares 

of Total Foreign Direct Investment in 

Asia 

Foreign Direct Investment in China’s 

Neighbors as Shares 

of Total Foreign Direct Investment in all 

Developing Countries 

An increase of 1% of 

foreign direct investment from the 

world to China 

Increase by 0.55% Decrease by 0.23% Decrease by 0.19% 

Source: Busakorn Chantasasawat, K.C. Fung, Hitomi Iizaka and Alan Siu (2003a, 2003b). 

The studies examine the effects of China’s foreign direct investment on foreign direct investment inflows 

into Hong Kong, Taiwan, Republic of Korea, Singapore, Thailand, Malaysia, the Philippines and Indonesia. 

Table 6. China’s Two-Way Trade of Electric Equipment with its Neighbors, 

2003 

Exports of 

Electrical 

Equipment to 

China 

(US$1,000) 

Rank in Exports to 

China 

Imports of 

Electrical 

Equipment 

from China 

(US$1,000) 

Rank in Imports from 

China 

Taiwan 17,075,435 1 2,470,679 1 

Republic of Korea 13,224,831 1 4,122,382 1 

Singapore 3,432,677 1 2,869,225 1 

Thailand 1,984,551 2 888,914 2 

Malaysia 7,179,539 1 1,587,136 2 

Philippines 4,251,766 1 890,895 1 

Indonesia 346,577 7 632,660 3 

Source: China’s Custom Statistics Monthly, 2003, December. 

Table 7. Domestic Value Added Induced US1 of Chinese Exports, 1995, 

(US$) 

Manufacture of 

Electric 

Machinery 

and Instrument 

Manufacture of 

Electronic 

and Communication Equipment 

Weighted 

Average of 

All Sectors 

Direct Domestic Value-Added of Processed Exports 0.128 0.128 0.153 

Total Domestic Value-Added of Processed Exports 0.144 0.138 0.176 

36 

Table 7. Domestic Value Added Induced US1 of Chinese Exports, 1995, 

(US$)—Continued 

Manufacture of 

Electric 

Machinery 

and Instru- ment 

Manufacture of 

Electronic 

and Communication Equip- ment 

Weighted 

Average of 

All Sectors 

Direct Domestic Value-Added of Aggregate Exports 0.148 0.155 0.240 

Total Domestic Value-Added of Aggregate Exports 0.257 0.243 0.545 

Source: Chen, Cheng, Fung and Lau (2001). 

Vice Chairman D’AMATO. Thank you very much, Dr. Fung. 

And we’ll move right on to Dr. Scott Rozelle from the University 

of California, Davis. 

STATEMENT OF SCOTT ROZELLE, Ph.D. 

PROFESSOR OF ECONOMICS 

DEPARTMENT OF AGRICULTURAL & RESOURCE ECONOMICS 

UNIVERSITY OF CALIFORNIA, DAVIS 

Dr. ROZELLE. It’s my honor to give testimony here. And I thank 

the organizers for inviting me and look forward to rich discussion 

here today. I’ll be talking about the rural economy in particular. 

And what I want to do is make several comments that are in my 

written testimony, but try to sum up some of the key points. Two 

decades of economic reform have really changed the economic landscape of rural China. Per capita grain output has reached developed country levels. Rising imports—exports demonstrate that 

China is now able to compete in international markets off the farm. 

More than 200 million rural residents have found employment over 

the last ten years. Rural incomes have grown at 5 percent a year. 

But while this new landscape have many things that are very positive, China’s rural areas are plagued with serious problems. The 

biggest problem is the fiscal system. It’s an antiquated urban bias 

system that’s unable to transfer the large amounts of fiscal resources from urban to rural, from rich to poor. The rural financial 

system is also archaic, state-dominated, without incentives, 

laddened with nonperforming loans. It’s unable to intermediate 

capital for the rural economy. So given this background, what is 

the threat of China’s rural economy to the U.S. economy? I would 

really say there’s two to think about. One is direct. And that’s the 

threat of the rural economy taking over markets from the U.S., 

U.S.—in particular, U.S. agricultural sector. 

Although this is real—and I’m going to address it briefly right 

now—I want to say right up front that I believe in the grand scope 

of things that we’re talking about here today that this is relatively 

minor. 

In fact, China is probably going to help U.S. farmers as much as 

they’re going to hurt them; probably help them more. As—let me 

address this first. 

As China begins to integrate itself into world agriculture trade 

community, China’s agricultural sector is going to be a force in 

some world food markets. Watch out for vegetables, fruits, livestock, agriculture. The cost of producing these labor-intensive commodities are sometimes less than 30 percent of the cost of proVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00042 Fmt 6633 Sfmt 6602 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
37 

ducing the same commodity here in California. Of the many goods 

I’m talking about, they include a whole spectrum of goods: apples, 

oranges, peaches, strawberries, vegetables, walnuts, et cetera. 

My opinion is that China will gradually become the number one 

competitor of U.S. horticulture exporters, first in Asia and someday 

even in the U.S. markets for a number of commodities. So it’s going 

to be a smaller number of commodities: garlic, honey, asparagus, 

other specialty goods. 

This message, of course, does not make me very popular in my 

home state when I give talks to agribusiness in California or Arizona. But this is what I mean by a threat. Of course, when I give 

this same talk in Indiana or Illinois, the audience is much different. China’s, by far, the largest importer of soybeans in the 

world. We predict that corn is going to be following very shortly, 

not to mention the rising imports of cotton, hides, wheat. So if 

there’s a threat in one subsector, it’s likely going to be offset by 

progress in the other. And if China isn’t a threat on the supply 

side, it’s not going to be on the demand side either as we think a 

little more broadly. In other words, China is not going to starve the 

world, as was once hypothesized by certain observers. 

An alternative way, really, to ask this question is, does China 

have the technological know-how to make its agricultural increase 

in productivity in the coming decades? When we think about this, 

we need to think about productivity as in the agricultural sector of 

the U.S. It’s grown at 2 percent a year for more than 100 years. 

And all of that increase in productivity has come from technology. 

So when we think about China, it—will China be able to have this 

technological know-how? If we look at its record in the past, the 

past they’ve done a good job in technology support of agriculture. 

Productivity since 1980 has risen from 3 to 4 percent a year. 

What’s behind it? Well, certainly there’s reforms and changes of incentives, but we’ve calculated that almost half of that rise is from 

technology in the past. Every two to five years the typical China 

farmer will adopt an entire new basket of varieties. 

The productivity of germ plasm today—that’s in China’s experimental station that’s going to be the productivity embodied in the 

seed tomorrow—has risen at about 2 percent a year. So China has 

had the new technology in the past and it currently has a stock 

that it will get it into the immediate future. But China’s longer-run 

future hopes is clearly being placed on plant biotechnology. 

In 1999 China spent about 100 million U.S. dollars in PPP terms 

on plant biotech, more than the rest of the developing world combined. 

But that’s not the end of the story. In 2000 it announced a major 

push in plant biotech and planned to spend a half a billion dollars 

a year by 2005. That goal’s almost being reached. And when it is 

reached, China’s going to outspend the U.S. Government in plant 

biotech research, though China doesn’t have a private research sector in agriculture. 

So China will still be spending less because it doesn’t have the 

private companies to do so. China had used these funds in the past 

to create true technological breakthroughs. It has the only gene-insertion method that can rival Monsanto’s. It has its own varieties 

of BT cotton. And it’s almost ready to release a novel rice variety, 

38 

which would become China’s first real GM food crop that stacks 

two insect-resistant genes into a single seed. Such technology, 

China believes, will help it produce more food or at least the same 

amount of food at lower costs to keep its economy successful. And, 

of course, it’s not going to starve the world. 

If any part, however, of the rural economy will directly—we’re 

still talking about direct threats to the U.S. from the rural economy’s perspective—it’s probably its rural, labor-intensive industrial 

economy and its counterparts in small cities and towns. These are 

the areas that China’s light industry manufacturing might has 

risen the most. I’m not an expert in this area of industrial policy 

and exports, but I have written several papers on the privatization 

movement of rural firms in which more than 1 to 2 million firms 

have been privatized since the 1990s, and most of them have enjoyed a rise of efficiency. I was also recently in rural parts of the 

booming coastal area and have been observing an emerging phenomena called industrial clustering. In one township 135 drill 

motor manufacturers, including Black & Decker and Makita, and 

every major company in the world, built factories in one development zone. 

In another irrigation pump cluster of 500 firm manufacturers, 

they produce more than half of China’s pumps and half of the 

world exported small pumps in three villages. 

600 shirt makers in another village, makers of 95 percent of the 

world’s glass frames in another township, silicone chips in another, 

Christmas tree decorations in another. These firms are self-organizing. They’re private. They often have foreign direct investment 

as a seed. And they work under few regulations. They don’t have 

lawyers to deal with contracts because when they regularly subcontract orders to each other or deal with subcontractors for parts, 

there are no written contracts. The firms are competitive, and they 

know how to manufacture many things. I think more manufacture—more competition is coming from these clusters. 

Let me conclude with just mentioning the other potential threat, 

the one that’s indirect. That’s the one that’s going to be realized in 

the event that the rural economy would become destabilized and, 

in turn, affect the stability of the rest of the economy. 

This is based on an idea that the economy is suffering—rural 

economy is suffering from a relative deprivation versus the cities, 

and some observers believe that it’s possible that rural residents 

would become disillusioned with the gross process turned from productive to destructive ones. 

In its most violent form, farmers would turn into the age-old 

practice of rebellion that would slow down agricultural and rural 

production, weaken the confidence of investors and divert national 

resources to suppress this movement. For a number of reasons I 

really find little evidence that rural China is anywhere near this 

point of destabilized. I do realize there’s increasing coverage in the 

press, in the news media, both inside and outside of China, of expressions of discontent and organized protests. I also know that 

there are acts of corruption that inflame the passion of villagers. 

But the statistical record would suggest that such realities, while 

every bit true at least in the first decade of the 20th century and 

maybe beyond, might be partly or fully offset by progress that has 

39 

been made. Above all, despite the rural urban income gaps, almost 

all rural residents have had higher incomes and have significantly 

larger asset bases than when the reforms began 20 years ago. Even 

those in the most poor—in the poorest decile, the poorest of the 

poor have increased at more than 2 percent a year. That’s about 

the growth rate of the U.S. economy since World War II. 

In short, rural households now have more income, they’re more 

diversified, have more savings. I don’t think they’re going to be 

able to give up that—give up these things. These aren’t only statistical based; they’re based on my own observations. I spend six 

weeks to three months a year in rural China, and people, both Chinese and foreign who do the same—basically our observations accord with the statistics. 

Direct observations show that rural people, while having many 

complaints, just like my farming grandfather always had lots of 

complaints, also have many plans for the future and starting new 

businesses, sending family members to the cities. I don’t know if 

you’re hearing a rosy picture of China or not. It should be taken 

with a note of caution. The last sentence, the policy package that 

will determine if this rural economy is stable or not is the one 

that’s going to drive development into the future. 

It’s going to be a hard thing for China to—sorry—a hard thing 

and lots of resources and hard decisions to make to reform the institutions and to make the massive transfer of resources to the 

rural economy that will improve its fiscal system, its financial system and its rural governance. 

That’s what we have to look at. If that improves, the economy’s 

going to be stable—the rural economy will be stable, and it won’t 

be this indirect threat. 

Thank you. I’ll stop there. 

[The statement follows:] 

Prepared Statement of Scott Rozelle 

Professor and Chancellor’s Fellow 

Department of Agricultural and Resource Economics 

University of California, Davis 

The Rural Economy 

Background 

Two decades of economic reform have changed the economic landscape of China. 

Per capita grain output has reached developed country levels; many farmers shifted 

into higher valued crops, making decisions increasingly on market-oriented principles; the research system has helped push up productivity by almost double the 

rate of population growth, and the nation has by far the most sophisticated agricultural biotechnology program in the developing world—indeed many of its breakthroughs are of global importance. Rising food exports demonstrate that China’s 

farmers are now able to compete in international markets. Off the farm, more than 

40 percent of rural residents have employment; and about 100 million of them have 

moved to urban areas for employment. Rural incomes have risen dramatically and 

hundreds of million of people have escaped poverty during this time. Growth in agriculture, non-farm employment and rural industry and the transformation of domestic and international markets have changed the face of rural China and are playing 

key roles in the nation’s modernization. 

While the new landscape has certain elements that are positive, there are still 

great challenges ahead. With the transition from planning in the rural economy 

mostly complete, China’s main challenge has shifted to one of development. In China’s new environment the main metric of success will be the extent to which the 

rural economy can become an integral part of the nation’s push towards modernization. For China to successfully modernize, the nation’s economy will have to experiVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00045 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
40 

ence a fundamental transformation—from rural to urban and from agriculture to industry and services. 

The necessity of this shift is not only borne out by the development experience 

of every other high income country in the world (there are no middle or high income 

countries in the world that have more than 10 percent of their population engaged 

in agriculture), it is consistent with the nature of China’s economy. Land holdings 

are so small and other resources are so scarce that farming cannot raise the incomes 

of most households. The gap between rural and urban residents remains wide. China’s policy effort largely needs to establish linkages between rural and urban areas 

and encourage the shift out of agriculture. The most important policy measures are 

those that improve the quality of rural China’s human and physical resources and 

infrastructure that will provide the skills and abilities to rural residents that seek 

to integrate themselves into the nation’s industrializing and commercializing cities. 

Successful development policy, however, must also recognize that modernization is 

a long process that will depend on maintaining a healthy agriculture and rural economy. 

Threat to US Economy and Security 

Most of the conceivable threats that could emerge in the rural economy are indirect and would be realized in the event the rural economy would become destabilized and in turn affect the stability of the rest of the economy. Caused by relative 

deprivation, some observers believe that it is possible that rural residents could become disillusioned with the growth process and turn from productive activities to 

more destructive ones. In its most virulent form, farmers would turn to age-old practices of rebellion that could slow down agricultural production, weaken the confidence of domestic and foreign investors and divert national resources in an effort 

to suppress or deflate the movement. In its less violent form, rural discontent could 

appear in a rural population that increasingly believes it is becoming 

disenfranchised and become less cooperative with its leaders and responds by becoming less willing to follow the policy directives of the state that range from family 

planning to tax payments. The threat that could emerge out of the less violent scenario would primarily be indirect and operate through a mechanism that would 

begin to create a less stable environment that would be less conducive to investors, 

which could slow China’s growth and trigger a series of problems (e.g., massive unemployment; financial collapse; fiscal weaknesses) that some argue are currently 

being masked by the expansion of the economy. 

For a number of reasons, I find little evidence that rural China is any where near 

the point that it is becoming destabilized. I do realize that there is increasing coverage in the news media—both inside and outside of China—of expressions of discontent, idiosyncratic acts of violence against local leaders and village headmen, 

more organized protests and even riots. I also know that there still are egregious 

acts of corruption that inflame the passion of rural residents when such acts hurt 

individuals or communities directly or impinge on rural society’s sense of injustice. 

It is also common knowledge that there are a number of chronic sources of irritation 

that are faced by villagers which are embedded in a number of institutions that are 

pervasive in rural China—for example, the lack of transparency in the way taxes 

are collected; the unevenness of the incidence of fees which are assessed for certain 

services; and the harsh ways penalties are sometimes imposed for policy violations. 

But the statistical record would suggest that such realities, while every bit true, 

at least in the first decade of the 21st century might be at least party offset by the 

progress that has been made in rural China in the past decade and the hope that 

rural families mostly have that the future will be even better than today. Above all, 

what should be noted, that despite gaps between rural and urban incomes that have 

widened during the past 20 years, almost all rural residents have higher incomes 

(rural income per capita rose almost 5 percent per annum since 1980) and significantly larger asset bases (for most households assets have grown faster than income 

during the 1990s) than when the reforms began 20 years ago. Per capita rural incomes have increased in all but 4 years since 1980s and even the incomes of the 

poorest decile (the poorest of China’s poor) have increased at more than 2 percent 

per year (about the growth rate of the US economy since World War II). Rural incomes have grown from many sources: the adoption of new technology; switching 

crops and selling their produce into newly emerged markets; participation in sidelines, livestock and aquaculture activities; the shift of family labor into the off farm 

labor market; and starting up of micro-enterprises and other entrepreneurial activities. In short, rural households not only have more income, they are more highly 

diversified (more than 80 percent of households in rural China now have a job off 

the farm) and have more savings in the form of liquid and non-liquid assets (such 

as housing and durable goods). The optimism of rural society is perhaps best epitoVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00046 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
41 

mized by a survey conducted by two British economists in conjunction with the professional rural and urban enumeration teams from China’s National Bureau of Statistics. When asked a number of questions designed to find out if people in rural 

and urban society believed they were better off now that in the past and believe 

that they will be better off in the future than they are now, a large majority of rural 

households responded that they were happy and were optimistic about the future. 

Moreover, my own observations (and the observations of most other social scientists—both Chinese and foreign—who spend a lot of time on the ground in rural 

China) are in accord with the statistics. Anecdotes and isolated incidences of protest 

aside (which may, if anything, mean that rural China is opening up to the point 

that expression of discontent is allowed, even when from time to time it happens 

to turn violent), I would argue that currently the rural economy in a number of 

ways is more stable than the rest of the economy and that, if a number of forthcoming challenges are met, the rural economy will play a positive, stabilizing and 

productivity-enhancing role in the coming years. But, having spent many weeks 

(and sometimes months) each year for the past 15 years doing surveys and interviews in all different parts of rural China with survey teams from the Chinese 

Academy of Sciences and other academic research institutes, one can tell that life 

in rural China is getting better. Direct observation also shows that rural people, 

while having many complaints (which should not be equated with a tendency towards rebellion—just go to any farm meeting in US and get into a discussion with 

growers and suppliers about farm prices, government regulation, environmental 

laws, urban encroachment or any number of other issues and one can amass a large 

volume of complaints), also have many plans for the future. More than 40 million 

farm families began new business during the 1990s. The pace of emergence of such 

micro-firms is accelerating and firms are becoming more sophisticated, more capital 

intensive and producing more value added. People in all but the poorest, most remote villages are constantly planning their moves into the cities and more prosperous rural areas to find a wage-earning job. Currently there are more than 100 

million migrants from rural areas in China’s cities; most of them are from areas 

that have below-average incomes. 

If this is the real picture of rural China, the real threat to the stability of China 

and through this the stability of the nation will only materialize if the process of 

rural development slows or stalls. In other words, the way to calculate if rural 

China will pose an economic or security threat to the US will be to assess if China 

can clearly state its rural policy objectives that will continue to allow the rural economy to flourish. And, of course, if China’s leadership also can execute those policies 

successfully. While this may seem like a rosy picture of rural China, it should be 

taken with a note of caution. The policy package, while more or less known, do require a lot of resources and will depend on hard decisions of the leadership to reform institutions that will require fundamental restructuring. In the appendix attached to this brief, I review the strategic objectives that China needs to adopt and 

discuss some of the main challenges that will face the leaders that decide to take 

on the challenge of modernizing rural China. 

Appendix 

Rural Development in China: New Challenges in a New Landscape 

Strategic Objectives 

In their pursuit of rural development, policy makers face two fundamental and 

inter-dependent tasks: 

First, the new era reformers are going to need to change the organization of government. A new framework for managing fiscal and other governmental matters is 

needed to meet the needs of the modernizing and increasingly market-oriented economy. The new institution also needs to instill a new ethic into government; officials 

need to change their role, becoming facilitators of economic growth and equity, not 

direct actors. Reformers also need to encourage the emergence of new partnerships 

with rural citizens. China needs to promote Farmer Professional Associations that 

can help in the process of development and assist government in taking care of vulnerable groups. 

Second, a concentrated effort is still needed to improve the resource base of the 

rural economy. Despite the great progress of the past 50 years, many parts of the 

agricultural and rural sectors remain underdeveloped. There are 50 million more 

farmers in China than at the beginning of reform. Farms are fragmented, small and 

getting smaller. Other resources—water and forests—are just as scarce. Farm 

prices, at least for certain commodities, will almost certainly fall as the nation implements its WTO commitments. In such an environment the state and its partners 

42 

have much to do to help farmers increase their resource base. China’s most abundant resource, its rural population, needs to be the target of a sustained drive to 

increase it human capital. Land, water and forests also require large investments 

and new institutional arrangements that can increase the productivity and incomes 

of households. Millions of people remain at or under the poverty line; most are poor 

farmers in remote, mountainous areas of China’s western provinces. In short, if the 

government can create the new institutions to transform the government role in development, foster a new partnership with the people and improve the resource base, 

rural incomes can rise and the rural economy will be a force in China’s modernization drive. 

Rural Development Priorities 

While a rural development plan has many components, we restrict our attention 

to three broad issues: (a) the nature of China’s new economic landscape and measures to enhance it; (b) changes that are needed to improve rural government and 

its partnerships with the rural population; and (c) reforms and investments that can 

improve China’s resources: labor, land, capital, water, forests and the environment 

of the poor. 

Enhancing China’s New Landscape 

China’s rural economy is on the brink of a new era. Much of the rural economy 

has successfully passed through the transition from a planned economy to one that 

is more market oriented, and most inputs in China’s rural economy are now under 

the control of farm households. The government can lead China into a new era by 

redefining key food policy priorities; fostering markets; completing a set of grain 

marketing reforms; and continuing to integrate China into international markets. 

Changing Priorities on Food Security: With such a large population and limited 

resources, China’s leaders have always placed a high priority on food security and 

their efforts have made remarkable progress. Since 1983 China has been a net food 

exporter. Even if the nation completely liberalized all trade (which is beyond its current trade commitments), by 2020 rice and wheat will still be almost fully produced 

in China. Although the nation will be a net importer of maize and soybeans, by 2020 

the export of vegetables, fruits and livestock and aquatic products will grow faster. 

With such a strong agricultural sector and the need to raise rural incomes, China 

should change the priority that it places on national grain self sufficiency. The recent policies to promote crop diversification are appropriate—as long as the planting 

decisions are made by the households themselves. Trade policies that artificially restrict grain imports also are not needed for national food security. Protectionist 

measures not only create international tensions, they cause inefficiencies and stifle 

structural change. Self sufficiency policies also slow down exports of labor-intensive, 

higher-valued products and reduce rural incomes. Other countries will keep their 

borders closed until they perceive that China is fulfilling its trade agreement promises. And, of course, even if at some future time the nation needs more grain, the 

land is still there and grain can be grown at any time. 

Instead, a redefinition of food security is needed. In place of national food security, leaders should shift their attention to measures that promote household food 

security among China’s poor. China’s main food problem is one in which the poor 

are not always able to provide their family members with enough nutrition, health 

or education. Since the problems are essentially those targeted by China’s poverty 

alleviation program, the current investment approach in poor areas that increases 

the productivity of the resource base and encourages diversification also will have 

the secondary effect of improving household food security. It is time that China 

makes this the new thrust of its food security policy. 

Fostering Domestic Markets: Few accomplishments can rival the government’s liberalizing of domestic markets over the past 20 years. The cost of shipping goods 

across China has fallen dramatically; the cost of shipping maize, rice and soybeans 

across the Northeast or down the Yangtze River is about equal to the cost of shipping grain down the Mississippi River in the US. Markets also have integrated rapidly; by 2002, prices between almost all pairs of markets across China—even those 

as distant from one another as Xian and Guangzhou or Heilongjiang and Shanghai—move consistently together for all major crops. Part of the improvement in domestic market integration is due to the construction of roads and improved communications. The improvements in China’s market also are from rising competition; 

since the mid-1990s, thousands of private traders have entered the commodity markets and arbitrage away price differences between regions. An important exception 

to this positive trend, on the input side, is the seed market, as raised in section 

Deepening Integration below. 

43 

1 China has promoted international trade, reducing average tariff rates, removing licensing requirements for many commodities, reducing the role of state trading and allowing thousands of 

enterprises to engage in the import and export of most goods. For example, average tariffs fell 

from more than 50 percent in 1991 to around 20 percent by the end of the 1990s. During this 

time, the total value of China’s agricultural trade grew by about 6 percent annually and the 

growth of agricultural exports has exceeded that of imports. 

With such well-functioning domestic output markets, it is not surprising that the 

government is considering the implementation of a new set of grain policy reforms. 

Although such experimentation is preliminary it is vital. However, the grain reforms 

may be most successful if they adhere to certain principles. While limited payments 

to farmers may make sense to facilitate structural adjustment, international experience suggests that China will not benefit from providing direct payments to farmers. 

Therefore, before making such a commitment the Government needs to realize that 

in countries that once started, the farming population quickly began to believe that 

they are entitled to permanent support from the Government and often it is difficult 

to eliminate such program. Instead, newly available resources should be channeled 

into public goods. At the very most, payments should be made for a limited number 

of years. Payments should also be de-linked from production decisions. Careful attention also is needed to set up a system that ensures payments actually reach 

households. Targeting should be based on easily observable indicators (e.g., countylevel cropping patterns and yields). The payment process also should be simple and 

use easy-to-observe criteria (e.g., provide payments to farmers based on their holdings of ‘‘responsibility land’’). The program should be highly publicized so that farmers who are entitled to the payments can get them. China’s agricultural policies are 

among the least distorted in the world. China should take pride in this and treat 

it as a valuable asset. To modernize, China does not need to make direct payments 

to farmers. By avoiding such payments, China will quickly become known as an efficient manager of its agriculture. 

Deepening Integration Across the Border: Although there are concerns about the 

impact of an increasingly open economy on China’s producers, there are many reasons to believe that the nation can benefit greatly by carrying out its WTO agreement with only a minimum negative impact.1 Workers gain access to employment. 

Consumers benefit from lower prices. All producers benefit from lower fertilizer 

prices. Producers of rice, most vegetables and fruits, many livestock and aquatic 

products and other higher-valued, labor-intensive goods also will benefit if WTO 

leads to higher exports. While producers of barley, soybean and other edible oils 

were hurt by liberalization during the 1990s, most of the fall in the prices of these 

commodities had already taken place prior to the WTO agreement, so the agreement 

will have little effect. Only maize, cotton and wheat farmers will be adversely affected. However, because most farmers are highly diversified and are able to change 

products if prices fall, the overall cost will be small. The only groups that are likely 

to need support are poor maize, cotton and wheat producers in the Central and 

Western parts of the nation. According to China’s own estimates, however, the annual loss due to WTO to these households (who are the most vulnerable of all households) only averages about RMB50 per household. A policy that compensates such 

households by RMB50 per year for the first several years after WTO (e.g., through 

a direct payment policy or a policy that eliminated tuition and school fees for households in these areas) would more than offset the negative consequences. 

To get the most out of its trade policy, however, China needs to make complementary policy efforts. Chief among these is to allow farmers to have access to the lowest priced and most productive inputs and technologies from inside or outside China. 

The WTO agreement challenges China’s farmers with competition in output markets 

from producers in the rest of the world. To compete, farmers need to have access 

to the same low-cost inputs and same high-quality technologies. There are many restrictions keeping seeds and other inputs from moving around the country. There 

also are barriers against the importation of inputs and technologies or investment 

by foreign technology firms. These should be sharply reduced and eventually eliminated in order to improve the income of farm households. According to international 

experience the entry of foreign seed and technology firms into the country could lead 

to both more competition and better transfer of technology. 

Restructuring Rural Government and Partnerships 

In trying to promote rural development in China’s more market-oriented environment and to take advantage of the rural economy’s dynamism, reformers need to 

reorganize government, especially the way it manages and monitors fiscal expenditures. Reformers also need to encourage the emergence of Farmer Professional AssoVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00049 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
44 

2See accompanying World Bank Policy Note on Public Finance Reform and Macroeconomic 

Management for details on a proposed reform program., including an examination of the rural 

Tax-for-Fee pilot. 

ciations and other rural interest groups that can partner in the process of development. 

Rural Fiscal Policy: The conduct of public finance is arguably one of China’s biggest problems. The fiscal system, as designed, is out of date, generates inadequate 

revenues, poorly redistributes collected revenues and does not provide enough public 

goods. There are problems on the side of expenditure and revenue mandates at the 

sub-national level, as well as the way government transfers work. The problems 

with the provision of public goods and services for the agriculture economy, and 

more generally for rural development, are a subset of the larger problems with 

inter-government finance in China, and need to addressed in the context of a broader public finance reform program.2

Examined from this point of view, the recent Tax-for-Fee Reforms, while well-intended, are unlikely to solve rural China’s fiscal problems. Tax-for-Fee is an attempt 

to reduce the tax burden of farmers in a system that is already characterized by 

deficient revenue generation and public service spending at all levels. Studies have 

shown that not only are savings to farm households minimal (only around RMB30 

per household), when collections fall, public services fall. Fiscal resources in poor 

deficit areas are already insufficient to meet the investment requirements. Over 70 

percent of counties and townships are in chronic deficit. While there are many adverse consequences of the indiscriminant fee collection, the root cause may be the 

system’s own design. Increased pressure at counties and townships to generate revenues to meet the system’s un-funded mandates leads to excessive fee collection. The 

tax system, which remains heavily industry-based, can distort investment incentives 

and induce local governments to promote industrial development even in areas without a comparative advantage in manufacturing. 

The reforms need to go beyond Tax-for-Fee Reform and consider the way expenditures are managed. The first step needs to be a review of the public goods and services that are needed in rural China. Realistic goals and priorities should be established for their provision. Each level of government needs to be handed clear responsibilities for the provision of a subset of the public goods. The resources needed to 

provide the public goods also need to be clearly defined. Leaders need to insure that 

sufficient resources are available to support the expenditures needed to meet their 

mandates. In the process, expenditures also need to be reorganized. Many tasks can 

be relegated to non-state entities. Many countries in the world have used alternative 

institutional arrangements to deliver key rural public goods without the direct involvement of the government. The rapid expansion of China’s non-state sector, particularly in the area of services, means that such a restructuring of the government 

role could relieve some of the pressure on public finance, and possibly improve the 

quality of public services to support rural activity. Even though such reforms in 

China will be disrupting, they need to be implemented in a comprehensive way. To 

minimize the disruption for the nation as a whole, we believe rural fiscal reforms 

can begin with regional experimentation, once the nationwide crisis in inter-government finance is addressed. 

Role of the State and Rural Partnerships: At the base of the rural public finance 

reforms lies a shift in the role of the state and development of new partnerships 

with citizen groups to carry out efficient and equitable growth. Although the Government moves out of the direct provision of many goods and services, it needs to 

be redirected to providing public goods, overcoming market failure and providing 

useful services that the private sector is unlikely to find profitable. To effect these 

changes, the main task of leaders is to comprehensively redefine the role of government and make explicit to various levels of governments, bureaus and individual 

leaders what they should and should not be doing. Also, as the government gets of 

direct production, it will be in a better position to create, implement and coordinate 

policies that involve conflicting goals. An example is the poverty alleviation policy 

to raise livestock (goats, sheep) in unsuitable areas resulting in serious environmental damage. Some sub-national governments have taken drastic but effective 

measures to manage natural resources while still helping the poor, but others need 

better guidance. 

In a modern society which is dominated by markets and assets and information 

are mostly in the hands of private individuals and enterprises, the government 

needs partners to carry out its tasks. China should begin to encourage the development of truly independent Farmer Professional Associations (FPA) as well as other 

information networks, business support groups, marketing systems and credit cooperatives. Today such institutions are still very weak in China. While there are 

45 

more than 100,000 farmer associations, their membership accounts for only about 

4–5 percent of all farmers and the structure of most is still ill-defined. 

Although the impetus to meet and act as a group must be from the farmers themselves, the government can create an environment in which FPA can thrive. First, 

leaders need to develop laws and regulations that promote and protect FPA. The 

legal status of groups needs to be clear. FPA need to have the ability to enter into 

contracts and take loans. Also beneficial would be regulations that enable farmers 

to organize themselves into locally-run credit cooperatives. FPA need the authority 

to be able to act for the members of their group as well as to be subject to welldesigned regulations that protect the membership from the leadership, including the 

way in which the leadership is selected and monitored. Second, the experience of 

FPA in other countries has shown that even when a favorable legal and regulatory 

framework exists, an independent catalyst (that is, someone or group outside the 

government) is often needed to get FPA started, expand and perform better. While 

China has a number of FPA-promoting agencies, these institutions are controlled by 

the Government. Alternative models should be sought to create catalysts that are 

first and foremost responsive to the needs of farmers’ and FPAs. The main role of 

such an advocacy organization is not to control FPA, but to facilitate their creation 

and provide information that allows its members to promote the interest of the association. 

Investing in Rural China’s Resources 

Improving the productivity of resources should have a direct effect on the welfare 

of rural residents—by raising their incomes and making them less vulnerable to 

risk. Having a better resource base also will provide farmers with the means for 

making major decisions to move off the farm, migrate to the city or to make productive investments. 

Preparing Labor for Migration Out of Rural Areas: Development is more than 

making the farming sector more productive. Access to off-farm jobs is the conduit 

through which occurs the shift of population from rural to urban occupations and 

from agriculture to industry and services. Although China has been late in starting 

the demographic transition, in recent years the status quo has changed faster in the 

off-farm sector than in any other. The beginning of the breakdown of many barriers 

in both rural and urban areas in the mid-1990s started an unprecedented, and perhaps irreversible, flow of labor to the cities. Despite the macroeconomic conditions 

of the late 1990s, the surge in off-farm employment not only continued after 1995, 

it accelerated. Almost 80 percent of rural households have at least one member in 

the off-farm sector. But the current labor flows are different from those in the past. 

For the first time rural workers show signs of specialization. Young workers—both 

men and women—are much less likely to work on the farm than older workers. In 

2000, more than 75 percent of men and women between 16 and 25 worked in the 

off-farm sector, almost double the rate of 16-to-25 year olds in 1990. Almost all of 

them live away from home. They are not working in local enterprises. Most of them 

are moving increasingly far from home. Perhaps most important, many of the young 

people that work in off-farm jobs have never farmed. Firms with migrant workers 

have much higher efficiency and exporting firms employ a higher proportion of such 

workers than firms producing for the domestic market. Employment off the farm is 

the main way that rural residents increase their incomes and attenuate inequality 

among regions and sectors and is one of the most important determinants of poverty 

alleviation. 

Despite the progress, the movement of workers off the farm has just begun and 

there are many barriers. Because the ability to find a job off the farm is inextricably 

tied up with human capital, investment in education and health will do more to facilitate off farm employment than any other policy. Since the beneficiaries of human 

capital investments are those outside the immediate rural community (i.e., the factory owners in industry and consumers of services in urban areas), international experience shows that the central government must take responsibility for investment 

in rural education and health. In recent decades, however, rural education and 

health have been left mostly on the shoulders of local governments and the poor 

households, although noteworthy efforts have been made in the past several years 

to increase the funding of rural schools, especially in poor areas. Complementary 

policies—in both the rural and urban sectors—also could help encourage the rise of 

off-farm employment and contribute to the increase in productivity that occurs when 

rural residents move to urban areas: investment in rural health; policies that encourage the expansion of rural industries; the relaxation of employment regulations 

in urban industries; easier access to urban housing, education and social services 

are some examples. 

46 

Raising Productivity on the Farm: China’s research system has increased productivity for major staple crops at more than 2 percent annually during the reform era, 

a rate of growth that is considered healthy by international standards. More than 

60 percent of China’s productivity rise came from new technology. China’s investments in biotechnology raised the productivity of cotton producers by nearly 25 percent and improved farmer health. However, the traditional system of research faces 

great challenges. Agricultural research in China, which is almost totally publicly 

funded, has always been focused primarily on the grain crops in irrigated areas. 

More than 80 percent of China’s research budget was targeted at the major staple 

crops. With scarce financial resources, sub-national governments (which have accounted for most of China’s agriculture research—a feature that is unique to China) 

have become reluctant to invest in research and extension. Despite recent increases, 

China still invests less than 0.5 percent of agricultural GDP in R&D, a level far 

below other countries. Unfortunately, few resources are targeted at the problems 

faced by either farmers in poor areas or to the basic research that can support new 

technologies to support a move into high-valued crops that are in demand in urban 

and export markets. 

Given the small size of China’s farms and likely post-WTO competition, the Government needs to keep the nation at the forefront of technological development in 

order to raise farmer incomes. Investment in agriculture technology needs to be 

raised sharply. Spending on agricultural research in China should be maintained at 

a level that is at least 1 percent of agricultural GDP (compared to the US, Canada 

and Australia, which regularly spend between 2–4 percent of agricultural GDP). The 

funds need to be better targeted. In the same way that the Government has reformed research in other sectors by focusing funds on the best scientists, promoting 

competitive grants and commercializing certain tasks (e.g., in the case of agriculture—the development of hybrid maize and certain horticultural crops can be 

performed by the private sector, as they are in most other countries), agricultural 

research reform is needed. While high potential projects should be supported, administrators need to set aside funds that will benefit farmers in poor areas. A policy 

that encourages the emergence of private research and seed firms is needed to take 

advantage of the ideas, capital and entrepreneurship of individuals. 

China also needs to maintain its position as one of the global leaders in agricultural biotechnology. In the late 1990s China invested more in agricultural biotechnology research than all other developing countries combined. Its public spending on agricultural biotechnology was second only to the US. In recent years there 

has been increased support for research. While such investments have created a 

great deal of potential, the gains need to be realized. Large increases in productivity 

and health are possible when scientists are allowed to commercialize their products. 

This suggests that the government move forward with its commercialization of selected crops, such as indica rice, wheat and certain other crops. Recent research 

shows that consumers in China currently are accepting the new technologies; they 

have opinions that are more similar to US than European consumers. The promotion of new bio-technologies, however, delivers highest returns when products are 

channeled through an effective bio-safety system that allows commercialization only 

when they are safe, and keeps unapproved products off the markets. Therefore, investment is needed in the regulatory system that monitors the biotechnology program during research and after commercialization. As in the case of cotton, China 

has benefited greatly from the participation of foreign firms and farmers have 

gained high returns from using imported technology. 

Encouraging Land Rental Markets: Secure property rights and well functioning 

land markets are considered important catalysts for economic growth, as they make 

investment worthwhile and facilitate transfers of land to the most efficient users. 

The efforts of the central and local governments over the past decade and the new 

Rural Land Contracting Law have solved most of China’s land tenure security problems. Poor tenure security seems to have only minor effects now on either agricultural investment or production efficiencies. It is important, however, that central 

and sub-national governments make a strong and sustained effort to implement and 

enforce the new regulations. To do so, the central government needs to make repeated efforts to publicize through the various channels the salient clauses that affect farmer rights. Strong directives through both the Government and Party hierarchy need to convey the importance of the Law. 

In addition to implementing the new Law, additional efforts—especially in the 

area of land registration—are needed to promote well functioning land rental markets. In an economy such as China’s (scarce land; off-farm employment becoming 

the main source of future income for most farmers; Government unable to use price 

policy to inflate returns to land), households with opportunities off the farm need 

47 

to be able to rent their land out, and those that are left in the village need to be 

able to rent land in to be able to raise their incomes from farming. 

Although rental transactions should occur between households that are seeking 

to improve their welfare, there is a role for Government in promoting the mobility 

of land among users. World Bank experience in other countries indicates that land 

registration can lead to increased rental market activity and lay a foundation for 

banks to begin to use land for collateral for loans. In general, registration gives additional protection to farmers by improving transparency in different types of land 

transactions. Moreover, if it is administered at a high enough level, farmers across 

large regions can be provided uniform certificates of documentation and this will 

broaden the market and make registration more valuable. For these reasons, a provincial level pilot for Land Use Rights Registration may be tried. It has been shown 

in other countries that land registration is one of the World Bank’s most productive 

and welcome loan packages (in terms of its impacts on raising the productivity of 

the agricultural economy) that is done with a minimum burden to the Government 

(land registration loans are largely self-financing, since registration fees paid by 

farmers are usually sufficient to pay back the entire amount of the loan). 

Experimenting with Rural Finance: The development of rural finance is a pressing 

issue. The effective implementation of many other policies (e.g., those that promote 

migration) and investments (e.g., those that encourage the creation of new technologies) rely on an effective rural financial system. Low levels of financial intermediation have affected the rural economy. According to one study, RMB1.3 trillion 

(in 2000 prices) of savings have moved from agriculture to industry between 1980 

and 2000; RMB2.3 trillion flowed from the rural to urban economy. While this direction of the flow is to be expected during development, the size of the flow is worrisome. International best practices suggest that the goal of rural financial reform in 

China should be to create a competitive, independent (from local government officials), market-driven and sound rural financial sector in which there is separation 

of commercial and policy lending, flexible interest rates and a wide variety of financial instruments (e.g., both short and longer term loans and deposits) available to 

borrowers and savers. The Government should begin to launch experiments to move 

in that direction as soon as possible. Experiments can be regional, focused on staterun banks and rural credit cooperatives (RCC) and designed with true experimentation in mind. Some of the early experiments could be done in the coastal areas 

since this is where the demand for credit is highest and the institutional environment in the banking sector most ready to change. The experiments need to examine 

a number of dimensions of the banking reforms, including: allowing interest rates 

(on loans; not deposits) to float in some areas, while restricting them in others; allowing the entry of other rural financial institutions, including private banks, in 

some areas and not in others; and providing deposit insurance in some and not in 

others. The key to the reform, however, is that the governance of the experimental 

banks needs to mimic those of a truly commercial bank. This can be only done if 

those that lead the experiment take full control of the banks in the experiment and 

seek to protect the capital of the bank, make the assets grow and seek to earn sustainable profits. In any experiment, banks need to be free from interference from 

local officials. 

Similar experiments can be done in the central regions of China, although differences in the economic environment and status of the portfolios will necessitate 

that the experiments will vary somewhat. Specifically, it is possible that in some 

areas, because the economy is growing slower, there will be less interest by private 

banks to enter. The existing financial institutions in central China, mostly RCC 

(and ABC in the areas in which they have not withdrawn) are also frequently burdened with many non performing loans. In such an environment—that is in one in 

which there are only heavily indebted state-run financial institutions that will not 

face competition from private bank entry—it is possible that a program of reform 

like that being advocated for coastal areas would fail. The danger is that even if 

managers were given better incentives and more authority to increase deposits and 

make loans, they would act in the same way as they did during the mid-1990s financial liberalization period (e.g., they could be inclined to continue to give loans 

for non-commercial purposes and not be overly concerned about making loans that 

could not be paid back). 

To offset this tendency, reforms in the central region would need several additional components. First, the experiment office would likely need to allocate more 

human resources to monitoring the actions of the banks in the experimental area. 

Second, a package of incentives needs to be offered to local governments (especially 

in counties in which RCC are part of the pilot projects) that would make them (the 

de facto ‘‘owners’’ of the local RCC and the entity most directly responsible for its 

48 

bad debts) encourage the local financial institutions to begin to operate as commercial concerns. Possible incentives include partial debt relief or promises of recapitalization. Finally, the experiments should encourage the emergence of non-formal financial institutions (such as, micro-credit programs and lending and credit programs run through new farming associations or other rural-based cooperatives). 

Some experimental areas may want to try to experiment with turning RCC into cooperatives or some other quasi-commercialized financial institution. 

While the main experiments in market-oriented, rural financial reforms may be 

most instructive if carried out in the coastal and central areas, there is room for 

experimenting in poorer areas, where one of the main goals should be to establish 

a clear separation of commercial lending from policy lending. This can be done by 

moving out all policy lending from the ABCs and other state-owned commercial 

banks and moving them to the Agricultural Development Bank of China (ADBC). 

Although the ADBC would need to link itself with a network of local outlets (e.g., 

contracting with RCC to implement their lending programs), the program design, 

flow and management of funds and monitoring and evaluation could be clearly centered in an institution that has no commercial interests. 

Facing the Challenges of Water Management: Water shortages pose a serious barrier to growth, are limiting efforts to alleviate poverty, and are becoming a major 

source of environmental problems. So far, no option has proved very successful in 

combating the problem of increasing water shortages. Unfortunately, traditional 

policies either no longer work (e.g., investing in increasing the supply of water— 

most of the water in northern China is already being used) or do not lead to real 

water savings (e.g., the promotion of technologies such as sprinklers). Such strategies are unlikely to solve China’s water shortages since they do not lead to real 

water savings. Even with South to North transfer projects, there will still not be 

enough water to solve the crisis. 

With the failure and infeasibility of traditional methods, there is need to turn to 

more ambitious water policies. While a more complete statement of our recommendations can be found in other sources (e.g., a publications by the World Bank, 

China: Water Resources Assistance Strategy, 2002, we summarize here the steps 

that the Government must take in order to begin to manage north China’s water 

resources. First, water savings in irrigated agriculture need to focus on reducing the 

water consumed per unit of crop production. This requires an integrated approach 

of improvements in irrigation technology, agronomic practices, and farm water management. Second, water management agencies need more authority to implement 

the difficult measures that are needed. Third, to achieve true water savings while 

avoiding inequitable outcomes, a system of water rights for both surface and ground 

water is needed, with rights extending to individuals that live in specific areas and 

the total amount of the rights limited to water availability after taking into account 

the environment and other needs. Fourth, after water rights are established, China 

needs to begin the investments and management shifts that will allow for volumetric pricing and regulation of water. Finally, with the institutions and facilities 

in place to implement a system of water rights and charge for water volumetrically, 

the nation can begin to move forward to raise water prices, promote new water saving technologies (ones that will lead to true water savings, such as, reduced-irrigation cultivation practices for wheat) and reform management institutions in order 

to achieve cropping intensity levels and cropping patterns, as well as municipal and 

industrial use levels that will be sustainable. 

The efforts on the conservation side must be matched on the pollution abatement 

side in order to stop the mounting, and often irreversible, damage to China’s water 

resources. Water scarcity is more critical when limited water resources become unusable because of water quality deterioration. In sum, it is not going to be easy to 

make the fundamental shifts, but of all the areas of resource management, getting 

water policy right may be the most important. 

Managing Forests and Grasslands: Actions to improve the environment in the 

middle and upper reaches of China’s main river basins are implemented through 

two directives. The National Forest Protection Plan (NFPP) banned logging in most 

of China’s . A Slope Land Conversion Program (SLCP) began paying farmers in cash 

and grain for converting millions of hectares of fragile and erosion-prone cultivated 

land into forests and grassland. While the full benefits and costs of NFPP and SLCP 

will not be known for decades, there are a number of policy actions that should be 

taken to enhance benefits and minimize adverse consequences. First, the program 

has been successful in setting aside millions of hectares of land—much of it fragile 

and sloped land—and it has provided farmers with compensation that has more 

than offset their lost earnings. Most rural households support the current arrangements, although they signal that if the payments cease, they will be forced to begin 

to cultivate the slope lands again. Therefore, there is a critical need to diligently 

49 

3 About 35 percent of grassland is considered to be moderately or severely degraded. 

follow through with official promises: to make full, timely payments directly to 

households and to provide farmers with high quality, appropriate forest and grassland technologies, giving households as much choice as possible. The programs are 

very generous, so there may be scope for some economizing later. The average payment to farmers in China (in PPP terms) is more than 10 times the average payment to farmers in the US Conservation Land Retirement Program, on an area 

basis. 

With regard to the NFPP, as the logging ban nears its fifth anniversary, measures 

are needed to address some of the serious costs from its implementation. Although 

the employees of the state forest farms have been provided with unemployment insurance payments, there are many groups of people who have been affected by the 

ban but not compensated. With the decline of logging output, the tax revenues of 

many counties have plummeted and the services funded by them have been reduced 

or eliminated. Rural residents in many collective forests have suffered serious negative and uncompensated income shocks. While the strict NFPP regulations may 

have been needed to initiate a new era of natural forest management, today policy 

makers need to foster a more integrated forest management strategy by promoting 

sustainable use of the forestry resources. 

Policies to address degraded grasslands have also been under active implementation.3 However, a coherent strategy for developing pastoral areas and for addressing 

grassland degradation is still lacking, caught between policy objectives for livestock 

sector development and sustainable management of grassland ecosystems. As a result, grassland management programs remain almost entirely focused on ‘‘technical 

fixes’’ such as fencing, with less attention paid to social aspects and economic costs 

and benefits. Because of the multifaceted dimension of the problem, actions will 

need to be taken on several levels. Effective solutions are anticipated to be institutional, organizational and behavioral, as opposed to technical. Implementation of 

measures, including monitoring and enforcement requires community level participation. The required measures include: (i) improved information on the condition of 

grasslands; (ii) refined models of grassland ecology and better integration of interdisciplinary approaches to design appropriate livestock management systems; (iii) 

articulation of the links between the biodiversity conservation and watershed values 

of grasslands and the economic benefits of development of pastoral areas; (iv) faster 

production and transfer of appropriate new technologies for grassland and livestock 

production; (v) improved market accessibility so that livestock off-take from the 

grasslands can be increased at critical times; and (vi) refined grassland tenure arrangements with emphasis on exploiting pastoralists’ traditional land tenure, assigning more authority to village-based institutions, and exploring alternative contracting methods, including community based grassland management. 

Policy Priorities for Rural Development that will Lessen the Emergence of 

Rural China as a Threat to US Security 

This policy note has raised a number of key policy efforts that China needs to 

make to allow its rural economy to continue to grow. Their implementation should 

enhance China’s economic environment for rural development, help restructure government and create new partners to share the responsibilities for development, and 

improve the productivity of rural China’s resource base. 

How should one gauge progress? While all policies are important to some degree 

or another, there are some, that I believe are more important than others. In other 

words, to assess China’s progress in fostering the development of its rural economy, 

one should follow progress in the following priorities areas: 

(i) In implementing its new rural policy agenda, the two most important, but 

complicated, problems facing China’s rural economy are getting the fiscal and 

financial systems right. 

(ii) While it may seem that progress in domestic market formation and trade liberalization make reforms in these areas less urgent (because of past 

progress), by pressing forward in these areas—e.g., by eliminating any remaining interregional barriers, liberalizing the imports and investments of 

seed and agricultural technology—China has a chance to make itself special 

among the nation’s of the world. 

(iii) With well functioning markets that transmit clear signals to producers and 

consumers, the investments in public goods and services will produce even 

greater returns. Reforms are furthest along in the areas of liberalization of 

labor and land. 

50 

• Encourage the development of truly independent Farmer Professional Associations. To do so, the most pressing immediate needs are the creation of laws and regulations and advocacy groups that will promote the FPA. 

• Increase allocations (to at least 1 percent of agricultural gross domestic product) 

and implement research reform in agriculture (inclusive of poor regions). 

• Investments in education and regulations that break down barriers to labor 

movement will encourage off farm employment, the main conduit through which 

most rural residents will ultimately pass through to reach a modern life. 

• If China rigorously implements the land laws and begins provincial Land Use 

Certification programs, tenure security will be improved and farmers will be more 

willing to rent their land when the opportunity arises. 

• The problems of water are probably the most critical since they threaten longrun, sustained development in certain regions. Innovative experiments for water 

rights, volumetric pricing and other technology-based programs that can promote 

true water savings need to begin soon to find ways to rationally, efficiently and equitably manage the nation’s water supply. 

Panel I: Discussion, Questions and Answers 

Vice Chairman D’AMATO. Thank you very much, Dr. Rozelle. 

I’ll call on Commissioners to question one or more of the witnesses. And try and keep the question and answer to five minutes. 

Five minutes—we have quite a number of Commissioners. Commissioner Robinson. 

Chairman ROBINSON. Thank you, Vice Chairman D’Amato. 

I must say, Dr. Rozelle, that was a fascinating presentation. We 

haven’t heard a great deal of testimony on rural China, and we 

don’t have witnesses before us that have spent a great amount of 

time there. And that’s led to a lot of speculation of the type that 

you’ve talked about concerning how is this wealth and—disparity 

and wealth and social dynamic ultimately going to play out. I was 

fascinated by the clusters, I must say, and also the level of relative 

prosperity and contentment and—but I obviously buy the fact that 

this is still an untested—or the trial—or the-jury-is-still-out phenomena. But I’m very interested, of course, to see how the story 

progresses. And we’d like to keep in touch with you on it because 

it’s been a real resource for us. And we have to understand the 

rural economy and the go-west policy that’s akin to it. 

I actually had a question for Dr. Naughton, as well. That was not 

a question, but an observation. 

The breakdown between state sector and private sector, even 

though I think the term private sector is still somewhat loosely defined, is now 50/50 or 60/40 or overall? 

Dr. NAUGHTON. In industry, say? 

Chairman ROBINSON. In the country. 

Dr. NAUGHTON. Much more private than state sector because, 

first of all, all the farmers are private. 

Chairman ROBINSON. Right. 

Dr. NAUGHTON. Almost all the rural industry has been 

privatized, as Professor Rozelle could tell you much more than I 

could about that. And in the cities, the state sector is now down 

to about a quarter of output and labor force. 

Chairman ROBINSON. A quarter. 

Dr. NAUGHTON. Yes. 

Chairman ROBINSON. And it was 50/50 relatively a short time 

ago? 

Dr. NAUGHTON. Yes. About, say, four or five years ago. 

51 

Chairman ROBINSON. You had mentioned that there’s a 45 percent reduction in the state sector over the past five years. 

And yet, if you look at the U.S. capital markets and the enterprises that China sends to the New York Stock Exchange and 

NASDAQ, you’ll take note of the fact that that’s over 90 percent. 

Dr. NAUGHTON. Right. 

Chairman ROBINSON. And as of two years ago it was a hundred 

percent. And that’s interesting to me as a financial type. I—you 

know, it occurred to me that there’s a hesitancy on the part of Beijing here in evidence, that there is even a, I think, a question of 

fundamental trust. But you would perhaps have a better handle on 

why you don’t see this dramatic trend line expressed in such a key 

area of activity. Because I think we all understand that they 

come—they cap markets to raise funds in a particular way, selling 

off only 10 or 15 percent of big state-owned enterprises to raise 

multi-billion dollars. 

It’s pragmatic and it’s successful, but it doesn’t really reflect the 

dynamic. And I’m wondering if you had any observations on that. 

Dr. NAUGHTON. I completely agree with you. I mean, that the 

process by which state firms have been listed on stock markets has 

been distorted and in some cases corrupt and something of a sham. 

I think in a sense the markets have voted that way themselves. 

The Chinese stock market—look what’s happened in the Chinese 

stock market. It’s at the same place—actually, slightly lower than 

it was three years ago. 

And here we are talking about the exploding Chinese economy, 

all these changes, the dramatic growth. Why? Because Chinese 

asset holders recognize that these are not good investments. These 

are state firms that have been structured in a special way in order 

to allow them to list and get some revenues from some of those 

managers. 

Luckily, that’s not where the action is in general. There are a 

few—you might find 40 firms on the Shanghai stock market that 

are quite good and 200 that are sort of Potemkin villages. 

Chairman ROBINSON. Thank you. 

Vice Chairman D’AMATO. Mr. Wortzel. 

Commissioner WORTZEL. I’ve got a few short questions. So I’ll try 

and give you as much time for each of you to answer as I can. Dr. 

Naughton, you were somewhat critical of the large-scale state plan 

on technology. And I think you’re talking about the March 1986 

plan in that the firms involved just didn’t pan out. But it seems 

to me that when we listen to the testimony, as a strategy of mastering whole areas of high technology for the nation, it’s been highly successful. We’re hearing—later in biotechnology, but in agriculture, certainly you’re talking about chips and things like that. 

So would you evaluate the overall strategy as successful and why? 

Now, I have a specific second question of you that you may want 

to defer to one of the panelists later in the afternoon. 

I have been trying to get my arms around the idea of what difference it makes from a security standpoint if China can manufacture 0.25 versus 0.18 versus 0.09-micron chips. What does that let 

you do in a weapon? Does it really threaten us? 

Dr. Fung, I was fascinated by your analogy of the German luxury 

car and the Italian sports car; but from what Dr. Naughton said 

52 

about the creation of standards sort of artificially by the Chinese 

government as a protectionist measure, it seems to me that your 

analogy of let’s not worry about it, it will all even out kind of 

breaks down if we can’t somehow stop that sort of protectionism or 

address that sort of protectionism. 

And, Dr. Rozelle, I’m going to take you way off base. You, in your 

testimony—your written testimony talked about the real problems 

of water management. Orally, you didn’t mention it., but what 

struck me are some of the large-scale water management plans in 

China or strategies that would seek to divert whole river systems— 

like the Irrawaddy, the Brahmaputra or the Mekong—that affects 

loads of countries downstream, some of which have been hostile to 

China. Do you see those panning out? And if so, do you see a larger, regional security destabilization from that sort of thing? Thank 

you. 

Dr. NAUGHTON. I guess I will go quickly. I think it’s very hard 

to evaluate Chinese technology policy overall because it’s big. It’s 

an elephant, and it depends on what part of the elephant we touch. 

Clearly, China’s done, I think, a very good job of sort of pouring 

resources into human capital without really knowing what they’re 

going to get out of it. 

So the number of people with some college education has gone 

from less than 1 percent to about 5 percent of the labor force, 

which for China, that’s huge. It’s a small fraction of the U.S., but 

it’s great progress. But when we look at specific industrial policies—let’s say industrial circuits. They integrated circuits. They 

spent at least 2 1/2, $3 billion in the ’80s and early ’90s importing 

production equipment into IC fabs for state firms. 

Where are those fabs now? The only one that’s still playing a role 

has essentially gone into receivership and been taken over by a 

Taiwan firm. And the key players that we’re talking about, that 

we’re concerned about, they’re all basically Taiwan firms. And the 

expertise and the know-how comes from Taiwan. So I would call 

that a failure for the industrial policy even though there’s something real happening and obviously they found enough skilled Chinese workers to make it work. 

As far as that line with the question, I’m going to have to pass 

to others who know a lot more than me about the security implication. 

Dr. FUNG. For the government intervention by the Chinese government to distort whatever market-based sort of model of the 

global supplied chain obviously is something that I think the U.S. 

Government should make sure that doesn’t happen. 

So while it is an efficiency response by U.S. multinationals, the 

builder is very highly productive global supply chain involving 

China, we do, of course, have to watch out that the Chinese government does not distort that sort of position. 

Dr. ROZELLE. Yes. It’s a very complicated question, the water 

management question, both groundwater management in North 

China where it’s particularly important and then the falling 

aquifers and then the ability to transfer water from south to north. 

I think from my reading of it, they’re totally committed now to 

building two, maybe three aqueduct systems, investing $50 billion. 

That’s two, three gorges, dams, to take water from the Yangtze and 

53 

take it to North China. It’s going to increase water by 15 percent, 

which is a lot of water. And it will probably solve their urban water 

consumption needs. 

Agriculture is going to be very hard hit. It’s probably very good 

news for the wheat producers of the world because I think that’s 

what’s going to happen is they’re going to go out of wheat. They’re 

going to go into single crop, maize or corn, and that we’ll see a lot 

more wheat—it’s going to be 10 or 15 years from now—finally go 

into China. I think the ideas of damming the Irrawaddy and damming the Brahmaputra, you know, are very expensive. The benefits 

are very low. They aren’t going to get the water up to North China 

where they need it. There’s some flood control—they can—— 

If they can’t negotiate their way—the Southeast Asian countries 

and the South Asian countries and China can’t negotiate their way 

out of that one, then we have a lot bigger problems than damming 

those rivers. So I think it’s a fascinating question. 

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

Commissioner BECKER. Thank you very much. I listened with a 

great degree of intensity to your testimony. And I’ve read most of 

the written information that we got in advance. I have no doubt 

that China has benefited greatly from the foreign direct investment 

from American corporations moving all or part of their operations 

to China. 

And I have no doubt that the multinationals have benefited 

greatly as a result of these astronomical profits when they export 

back into the United States. But when you look at this, I wonder 

if we’re getting a complete picture. You haven’t talked about the 

comparative advantage that China offers these firms to come to 

China, which is really an endless supply of cheap, exploited, repressed labor. And with the government that we have in China, 

that’s likely to stay that way. That’s not going to change. That’s the 

comparative advantage that they’re offering. That’s the comparative advantage that they’re keeping. Picking up on what Commissioner Mulloy of what’s happening here in the United States, we 

have an astronomical trade deficit that continues to rise. It’s $125 

billion for China alone, which kind of puts the trading relationship 

in some kind of perspective. Millions of industrial jobs have been 

lost, factories sitting there, rusting hulks. The communities have 

lost their tax base. And unemployed workers don’t contribute to the 

social stability of this country. They can’t pay for the Social Security, the Medicare and all the myriad of things that we demand in 

this society. 

I guess my question is, where is this going to end? What do you 

see as the future? You made a statement about what is China 

going to get out of it? 

My question is, what are we going to get out of it? What do you 

see for America? What do you see for small businesses and workers 

and the communities facing this? If we continue on with no change 

just like we are now, what’s your vision of America in the future? 

Dr. NAUGHTON. Well, that’s a really a hard question. And I don’t, 

you know, want for a minute to deny the fact that American workers, and especially manual workers, have suffered enormous impact 

from globalization in general and from the reintegration of China 

in particular. It’s not a comfortable position to be a manual worker 

54 

competing with not only a billion people in China, but, almost a billion in India and Mexico and Brazil. And the costs are real, and 

the adjustment costs are real. 

When you asked what my vision is for the long run, I think in 

the long run the successful economies of the world don’t threaten 

us nearly so much as the unsuccessful ones. It’s not China that has 

a huge trade surplus overall. It’s the U.S. who has a huge trade 

deficit. China has a modest surplus. It probably should have a bigger deficit, I agree. There’s some adjustment issues. But the overall 

deficit problem is one of our economic policy and not, I think, one 

of Chinese export policy. As China succeeds, it becomes a bigger 

market. It contributes intellectual wealth to the world. There are 

new forms of division of labor that emerge. 

So my vision is of a global economy in which the most successful 

economies stimulate each other and provide benefits to each other. 

I don’t mean to downplay the costs of that process. 

Dr. FUNG. The dislocation costs, obviously huge, particularly in 

low-cost, low-wage industries in the United States. So I think policymakers, as Dean Cowhey pointed out, probably have to come up 

with innovative solutions to compensate the losers of globalization. 

But at the same time it seems that the U.S. strength and vitality 

really is—it lies in a situation where we compete fairly and we 

compete globally. 

I think history with the Japanese—I used to work in the U.S. 

Government when we had a lot of trade issues with Japan. And 

there were a lot of people saying Japan is going to overtake the 

United States in all areas, auto and all that. I never believed that, 

partly because that I thought, how can such an open economy that 

attracts talent from all over the world, how can they lose? I can’t 

imagine that we’ll go the way of other economies. 

Now, it doesn’t mean that we don’t need some kind of policies 

sometimes to cushion us, give us some breathing room and also to 

compensate some of the people who are really, really hard hit, and 

we need to really take care of them. But at the same time I’m not 

sure what is a good strategy for the welfare of our country to sort 

of shut down this process of interacting with other economies. 

Dr. ROZELLE. I’ll try to keep it very short. 

I was thinking when you asked Dr. Cowhey about what you 

would tell leadership of the U.S. what they should do. And I’m 

going to talk about agriculture because I think that they’ve touched 

the main points there. 

Number one, I would find out—I think China is a tremendous 

potential market for our farm economy and for the manufacturer 

of inputs and technology. But we aren’t even close to tapping it yet. 

Number one, we don’t even know what’s happening over there. 

The Australian government outspends the U.S. Government on research on China by a magnitude or so. There’s a big black box 

when it comes over there to fare what we should be doing. 

Two, we definitely should be working on opening up markets. 

The role of the government is to identify the nontariff barriers that 

are fiction and open them up and to continue to work with China 

on future trade agreements and WTO-type agreements. I think 

China will be an ally to the U.S. in future WTO talks and its positive role in agriculture can help get the talks started or any other 

55 

Free Trade Agreement or free trade type of agreements that are 

going on. Three, we need to invest in industries here in using our 

comparative advantage, continue to invest in research and infrastructure. There are huge markets that are going to be tapped 

there. The U.S. farm sector can take advantage of them. 

And, finally, there is going to be structural adjustment here; that 

I think the programs that we have in place probably are sufficient 

to help that structure adjustment. They may need more in agriculture. 

Commissioner BECKER. Thank you. I want to offer two comments, which in the interest of time you may not even want to 

comment on. But we had a field hearing in South Carolina centered 

largely around the textile industry. We’ve lost hundreds of thousands of textile jobs to China. And other low wage or developing 

countries throughout the world have lost the textile industry to 

China. The only thing that has kept things a little bit stable is the 

multifiber agreement that was negotiated. 

Now, there’s no doubt in the textile industry’s mind or the workers that once that expires, it’s all gone. And the United States will 

lose another 400,000 workers in the—is it 400,000 or 4,000? 

Commissioner BECKER. 400,000 in the United States. And they 

predict millions throughout the lesser-developed countries that will 

be gone. 

I don’t know a solution for that. Can removing the tariffs and 

opening the barriers for trade with China—I want to give you another example. General Motors built a Buick division in Shanghai. 

A Buick made in Shanghai gets the company $10,000 profit. A 

Buick made in Detroit, the same Buick, same design, same everything, they get $1,000. Now, we’ve lost thousands of jobs in Mexico. 

We lost 75,000 General Motors jobs to Mexico under NAFTA. The 

automobile industry, which is one of the most important in the 

United States affecting so many ancillary jobs—is under attack. 

The original parts and aftermarket parts are being developed in 

China to supply the U.S. market and the Chinese market. I just 

want you to think about what’s at risk here and how you counter 

that. You don’t have to comment on it. I just wanted to get it out 

into the record. 

Vice Chairman D’AMATO. Let me move on. Commissioner Dreyer. 

Commissioner DREYER. Thank you. This is for any and all of you, 

but it is prompted by something that Professor Rozelle said. You 

were talking about being unpopular in the state of California because you have pointed out that the Chinese are able to produce 

certain agricultural commodities, such as apples, at a lesser price 

than the U.S. I have been watching with somewhat dismay the disappearance of the family farm in the United States because it cannot compete with agribusiness. 

And I am wondering what effect this would have—a similar effect, as it really has to, in the Chinese agricultural scene, in that 

large plantations, I know you don’t have apple plantations—but the 

plantation economy produces better product at lower cost. 

It would seem to me that the Chinese family farm also is being 

threatened by this same phenomenon we see in the United States, 

but that in Chinese context, because of the millennia long attachment to family land and ancestral graves and, also, of course, the 

56 

original ideology of the Communist party, which is to champion the 

interests of the workers and the peasants, would have on this. 

There don’t seem to be enough jobs in the urban economy to absorb 

permanently, this exodus from the rural areas. 

I, of course, read, as you do more so than I do, about the sannong 

wenti, the so-called three problems of agriculture, and the near 

paranoia of the leadership about instability in the countryside. And 

I wonder if you see any connection or prognosis for the future in 

there. 

Dr. ROZELLE. Okay. You know, first of all, in some of the work 

that’s been done by the USDA on China’s entry into Free Trade 

Agreements and emergence as an agriculture trade shows that actually the U.S. benefits a lot on an aggregate over the long run. 

Even today, the heartland—Illinois, Indiana, Iowa—from the rise 

of the price of soybeans versus other grains which are completely 

connected with China’s massive imports, that’s been the flip side 

of it, is that’s invigorated those economies and then all the linkages 

to the rest of those, you know. And so you’re a soybean farmer, 

you’re okay. You’re a textile worker in South Carolina and you 

aren’t. 

You’re right, though, when you’re saying that farmers in the U.S. 

fear this sort of supermarketization and corporatization of agriculture. 

Commissioner DREYER. I actually wasn’t worried about the U.S. 

farmer in this question. It’s China. 

Dr. ROZELLE. What I was going to say is this is happening in 

China as we speak. 

Five years ago 12 percent of Chinese food was purchased in supermarkets. Now it’s up to 40 percent. Within ten years 

everybody’s going to be shopping at Wal-Mart and Ahold and 

Carforre and the Chinese derivatives thereof. And it’s going to have 

a very big impact on the agricultural sector. We don’t know what 

it is. I actually don’t think the family farm in China is going to be 

directly threatened. They aren’t going to be replaced by plantations. What’s going to happen is their returns are going to go down 

as the same buying practices—that’s what I was referring to the 

U.S.—the same buying practices that they use here that cut costs 

and cut margins and do shelf-space pricing are going to be, you 

know, used and probably perfected, you know, in overseas markets. 

So this is something that we need to watch. Right now markets are 

very robust and farmers get hurt and get helped as prices go up 

and down. And so it’s something to watch. And I think that the agricultural lead-—the leadership in China, especially Wan Jabau, 

who is very, I think, personally concerned but also worried from a 

political economy standpoint, that’s why we—I’m watching very 

closely. 

Are we at a turning point in Chinese politics, when there’s a reversal of flows of resources from extracting from agriculture, are 

they going to put it back? So we have to watch that. 

Commissioner DREYER. Thank you. 

Vice Chairman D’AMATO. Thank you very much. Commissioner 

Reinsch. 

Commissioner REINSCH. Thank you. Mr. Naughton, I was struck 

by the exchange with you and Mr. Becker. It seems to me you’re 

57 

dealing with an important question, which is what, if anything, do 

we do to help make sure that the Chinese become a benign engine 

of economic growth, which would improve their prosperity, their 

jobs and promote stability in the region, and thereby help us for 

a lot of reasons. 

It seems to me you’re saying—and I agree with you—that one 

way to facilitate that is to maintain engagement, to maintain linkages, to maintain building an economic relationship. And I agree 

with you about that. I guess my question goes back to your analysis of the bilateral trade relationship, which I thought was incisive. I would like you to do two things. One is to comment a little 

bit on the stability of the triangle and what you see happening over 

the next few years in its evolution. And, second, relate that, if you 

will, to whether or not there are likely to be any sort of macroeconomic consequences of the enormous U.S. total deficit and 

things that might happen as a result of that that would affect the 

bilateral Chinese relationship. 

Dr. NAUGHTON. Thank you for your confidence in me in asking 

those questions, which are extremely difficult. 

Commissioner REINSCH. Sorry? 

Dr. NAUGHTON. I think the basis of the triangular relationship, 

I think, is actually fairly solid. The Taiwan firms and increasingly 

Korean and Japanese firms are getting back into the game in a big 

way. 

And there’s a distribution of intellectual resources among the different parties that is reasonably stable even though we’re all upgrading at the same time. 

Taiwan has formidable technological resources. And the business 

community of Taiwan, I think, has made a pretty firm commitment 

to the mainland, sort of exemplified by Taiwan semiconductor that 

for years was hesitant and skeptical and then now has gone ahead 

and started to construct a plant in Shanghai. So I think in that 

sense the triangular relationships fairly stable. Japan and Korea 

are coming back in. This picture of Japan that a number of us 

sketched of a country that lost out because it didn’t engage fully 

enough was very accurate for Japan in the 1990s. It may be changing rapidly. And so we might be seeing in a sense more—deeper 

interaction, more competition, more complicated division of labor. 

But I think the fundamentals are reasonably sound. 

The overall U.S. deficit, perhaps Professor Hanson can also address that later this morning. But it depends on whether the U.S. 

retains the technological and financial leadership to attract investment from throughout the world. As long as investment capital is 

pouring into the United States, which it seems to be—and some of 

that is from the Chinese Central Bank—then we can be in a sustainable deficit; not at the levels we’re at today, I don’t think. 

Commissioner REINSCH. Thank you. If I’ve got time, let me come 

back to you. First I wanted to ask Dr. Rozelle a question. Can you 

say a few words about the quality or the role of infrastructure and 

particularly transportation in the agricultural sector. 

Dr. ROZELLE. Yes. That’s a very important part of sort of this 

really emergence of a market-based agricultural economy and their 

ability to compete and their ability to buy and use world products, 

including U.S. goods, as they come in. 

58 

Basically what you have is coming from a legacy of socialism and 

Maoism where roads weren’t built purposely to divide the economy. 

China now has responded on the other extreme, and they’re building roads now faster than the Eisenhower Administration built 

roads in the 1950s in the U.S. 

The road infrastructure that’s going in, you know, across China 

is unbelievable. It changes triply for me, which is, you know, one 

or two trips a year. One year you’re on a small back road and the 

next year you’re on a four-lane freeway. Now, I’ve heard different 

discussions about how good these roads are, how sustainable they 

are, are they poorly constructed and everything like that. And I 

don’t know anything about that. But the road web and infrastructure is amazing. 

I have a paper where I show cross-sectioned. So take in a given 

one-week period prices that go from Shanghai all the way up to 

Chengdu inland. So take across there. 

And then I compare them to prices in the United States from 

New Orleans, up to St. Paul. And you look at those two, and 

they’re sloped exactly the same. 

China ships corn around at the same price and cost as the U.S. 

ships corn around its country now. 

And when a price moves in Heilongjiang in the northeast, in 

Maine we see prices in New Orleans or prices in St. Louis move 

at the same time. So there’s this increasing integration done by 

these roads. 

Commissioner REINSCH. That’s really interesting. Maybe you can 

share that paper with us if you don’t mind. 

Vice Chairman D’AMATO. We’re going to have to move on. 

Commissioner REINSCH. I’m out of time, but I’ll catch you on another occasion. Thank you. 

Vice Chairman D’AMATO. Commissioner Mulloy, we have to be 

relatively rapid. We’re running pretty late. 

Commissioner MULLOY. Yes. Dr. Naughton, Commissioner Becker made the point about the loss of jobs. And you were referring 

to the manual workers, the blue-collar workers. I think we’ve got 

to look at this in a larger political context. 

You know the present chairman of the President’s Council of 

Economic Advisors, Gary Mankiw, released a report the other day, 

and he said the outsourcing of white-collar jobs, which is going on 

at a very fast pace, is good for our country because it makes us 

more competitive globally. I don’t know whether you saw the political reaction to that, but I’m looking in the San Diego Union Tribune dated February 12th, today. 

The Republican speaker of the House, Mr. Hastert, has attacked 

Mr. Mankiw and said, this is lunacy to be talking about just letting 

these jobs go. The United States is the largest debtor nation in the 

world by far. We have the largest current account deficit in history. 

$500 billion this year, and that’s adding to our international debt. 

Even the IMF is worried about these irresponsible economic policies, as they would, I think, call them. As Commissioner Becker 

noted, this losses of jobs isn’t just jobs. These are our tax base. 

When you lose jobs, you don’t have taxes to do other things to improve your communities, improve your life and to improve even research and development. 

59 

Now, Dr. Fung on pages 7 and 8 of his testimony says, don’t 

worry about this. He says, Germany and France traded with each 

other, and they both did pretty well. But what Paul Craig Roberts 

and Senator Schumer is saying is, this is quite different when 

you’re dealing with economies which are quite different in terms of 

their economic condition. 

France and Germany had similar social, labor, environmental, 

and other standards. Now we’re engaged in trade with economies, 

which don’t have labor standards, don’t have environmental standards, and it makes it economically efficient for maybe a company 

to move jobs because they don’t face those costs in these other 

countries. So what may be good for the American high-tech industry may not be good for the American economy. 

I think if we want to remain engaged in this global economy, 

then we got to be thinking about what is it—how do we deal with 

these competitive problems? 

Clearly, massive trade deficits are signals that the United States 

is not competitive? What do we need to do? 

Dr. Cowhey said research and development. But I think you can 

help us by saying, okay. Here’s the problem, and here are some solutions to the problem. And if you could help us along those lines, 

I think it would be enormously helpful. 

Vice Chairman D’AMATO. Is that a question? 

Commissioner MULLOY. Yes. 

Vice Chairman D’AMATO. That’s a question. You can take it for 

the record. 

Commissioner MULLOY. You can submit that in writing. 

Dr. NAUGHTON. I would submit that in writing. I think that will 

take most of the day. 

Commissioner MULLOY. That would be enormously helpful for 

you and Dr. Cowhey and others. What is it that we ought to be 

doing? We want to remain engaged, but these political pressures 

are building. What do we do as a nation, and how do we respond? 

Vice Chairman D’AMATO. All right. Thank you very much. 

One quick more question for the panel. Commissioner Bartholomew. 

Commissioner BARTHOLOMEW. Thank you. I just want to take a 

moment to thank our hosts, Dean Cowhey, Professor Shirk and 

Ambassador Ellsworth. 

We’re out here in glorious California, and it’s difficult to see how 

anybody could have anything but an optimistic view of what’s going 

on. It’s an incredible state. It embodies the optimism, the hope, and 

entrepreneurial spirit that have made this country great. So thank 

you for sharing today with us, and thank you for hosting the Commission. 

I also wanted to particularly thank Professor Shirk and Dean 

Cowhey for their service to our country. And as a personal aside, 

I hope they will be joining us back in Washington sometime in the 

near future. We’ll be taking them away from you again. An observation. Dean Cowhey, I would like to speak with you about this 

separately, but the importance of freedom for innovation is something I think we really need to be focusing on. 

And it struck me as you were talking about hardware China, 

software India, whether some of that was freedom and democracy. 

60 

India software is more creative, hardware is a little bit more mechanical I wonder whether there’s any connection there, but we can 

take that up separately. 

My question for Dr. Rozelle is, a lot of what you say flies in the 

face of conventional wisdom about what’s going on in rural China. 

I’m just trying to understand. One of your sentences in particular 

was that people in all but the poorest, most remote villages are 

constantly planning their moves into the cities and more prosperous rural areas to find wage-earning jobs. 

How do you reconcile that trend with a more rosy interpretation 

about what’s going on in rural China? If things are going so much 

better in rural China, why are people looking to leave? 

Dr. ROZELLE. That’s a very good question. there’s one number 

that I think probably accounts for optimism of the rural economy 

more than anything, and that’s in 1981 when the reform started, 

4 percent of laborers had a full-time job off the farm. Okay. 

Today 45 percent of the people in rural China have an off-farm 

job, either full-time or part-time. 85 to 90 percent of households 

have one member off the farm. An incredible transformation. 

Now, why are they doing this? Why are they looking to leave? 

Well, there’s something called the iron law of development economics, which is portrayed by a very simple graph. On the vertical axis 

it’s the proportion of your population in agriculture, hundred percent up here, zero down here. Income along this axis. The world 

looks like this. There’s no rich agricultural countries. Okay. Two 

percent of our population works on the farm. 4 percent are in purely rural areas. France and Japan spend tremendous amounts of 

their budget to keep the rural culture alive. It puts them 1 or 2 

percent above the line. 

So, I mean that this is a natural and it’s a healthy shift of the 

economy. Every economy that’s ever developed has gone through it. 

China’s actually behind in this. And it’s because of their Maoist 

policies. 

So now, that’s the rosy side. 

The unrosy side is it’s a very painful process. I mean, you send 

your kid to a sweatshop is basically what you’re doing. Why do 

they do it? And it’s because it helps them diversify their risk. It 

does give them higher income. And it gives them a ladder to step 

up. 

We’ve shown that there’s this ladder that goes up over time. 

Commissioner BARTHOLOMEW. It sounds like you’ve spent a fair 

amount of time researching and talking to people. 

Is there any sense that people who are moving into urban areas 

have some hope of stabilizing their economic situation back home 

and that they want to go back to the rural areas? 

Dr. ROZELLE. Well, it’s very—there’s a professor at the University of California, Irvine, that has done—he’s a sociologist that 

talks to migrants. And in 1990 he did a study, and he found that 

almost 80 to 90 percent of migrants who were in Shanghai said, 

within five years I’m going to go home and continue to farm. Today 

he talks to these same—the different migrants, but the new cohort 

of migrants, and a vast majority of them—first of all, three out of 

every four 16 to 20 year old has a job off the farm. Okay. You talk 

61 

to that cohort, who’s in the rural urban areas, and they say, I’m 

never going to go back. 

And it’s going to be a challenge for them to stay because China 

still has a very pro-urban dualistic economy, but that’s starting to 

break down. And, you know, there’s where some more sort of food 

for discontent might come. 

Commissioner BARTHOLOMEW. Thank you. 

Vice Chairman D’AMATO. Thank you very much. And I want to 

thank the panel for your indulgence and being with us. We’re going 

to be sending you the transcript for your edits. We’re going to take 

a short break because we’re running late. We’re going to take a 

five-minute break, and then we’re going to go on. Five minutes. 

(Recess taken from 11:13 a.m. to 11:20 a.m.) 

PANEL II: CHINA’S TRADE AND INVESTMENT WITH ITS 

NEIGHBORS 

OPENING REMARKS OF VICE CHAIRMAN C. RICHARD D’AMATO 

Vice Chairman D’AMATO. We’re going to reconvene for our second 

session of the morning. Will the Commissioners please take their 

seats. We’re back to San Diego. We’ve got a hometown team here— 

three professors. The title of this panel is China’s Trade and Investment with its Neighbors. Professor Gordon Hanson of the Economics Department here at San Diego; Steve Haggard, Political 

Science, and director of the Korea-Pacific Program; Richard 

Feinberg, also a professor of economics at the Graduate School of 

International Relations here. We’ll do the same thing we did this 

morning. We’ll go from right to left. And if each of you would take 

a maximum of eight minutes to make your presentation, and then 

we’ll go to questions and answers, five minutes each. 

We’re going to go ahead and start with Dr. Richard Feinberg, 

professor of economics at the Graduate School here at the University of San Diego—University of California, San Diego. Go ahead. 

STATEMENTS OF RICHARD FEINBERG, Ph.D. 

PROFESSOR OF ECONOMICS AND 

STEPHAN HAGGARD, PROFESSOR OF POLITICAL SCIENCE 

GRADUATE SCHOOL OF INTERNATIONAL RELATIONS AND 

PACIFIC STUDIES 

UNIVERSITY OF CALIFORNIA, SAN DIEGO 

Dr. FEINBERG. Thank you, Mr. Chairman. Professor Stephan 

Haggard and myself are preparing a joint presentation here, and 

he will take the lead in presenting our major findings and conclusions at the outset. Thank you. 

Vice Chairman D’AMATO. Okay. 

Dr. HAGGARD. Thank you, Mr. Chairman. 

My purpose here is to shift the discussion to a consideration of 

some of the institutional and political issues surrounding trade and 

investment relations in the Asia-Pacific and how a Pacific community might be built. In particular, I want to talk about the explosion of subregional and bilateral trade agreements within the AsiaPacific over the last four or five years, and what risks and opportunities those might have for U.S. policy. 

If you look historically, except for ASEAN and the move towards 

an ASEAN Free Trade Agreement, there hasn’t been much institution building on the economic front within the Asia-Pacific region 

62 

that has lasted. APEC has lost momentum over the last five or six 

years after committing to the negotiation of a regional Free Trade 

Agreement in 1994, and that effort has been stalled. While those 

efforts have been stalled, we’ve seen a proliferation of bilateral 

agreements among some of the major powers in the region, most 

notably Japan, Korea and China. And this is really something new 

for the foreign economic policies of these three countries. Some of 

these agreements, such as the ones we see between Japan and 

Mexico or Korea and Chile, are motivated by efforts to get around 

what they see as the discrimination in our Free Trade Agreements. 

But the two real complexes of interest for American policy are what 

might happen in Northeast Asia and what might happen between 

Northeast Asia and Southeast Asia. 

Let me just start briefly with the Northeast Asian complex. 

Japan and Korea are now in the process of serious negotiations 

about a Free Trade Agreement. I suspect those negotiations will 

come to conclusion over the course of the next year or so. To date, 

the Chinese have not shown an interest in negotiating a formal 

trade agreement with either of those countries, although there 

have been rumors of such a possibility. As a result, the JapanKorea agreement will probably not be the nucleus of a broader 

Northeast Asian trade agreement. 

The real action has been between Northeast Asia and Southeast 

Asia. For some time the Koreans and the Japanese have proposed 

various types of arrangements with Southeast Asia, but the surprising development was the announcement in 2001 of the Chinese 

intention to negotiate a Free Trade Agreement between itself and 

the ASEAN countries. This would be a big development, particularly if it forecloses a broader East Asian regional agreement. 

The agreement looks like a pretty serious effort, at least as laid 

out on paper. It aspires to be WTO-compatible in the sense of freeing substantially all trade between the two parties, ASEAN and 

China. That was unexpected, although there could be a series of exceptions to that agreement. Moreover, the Chinese have sweetened 

the deal by extending a number of benefits on a short-term basis 

to the ASEAN countries in agriculture, the so-called ‘‘early harvest’’, which is a sign of the seriousness of their intent. Japan and 

Korea have tried to respond to China’s proposal, but because of agricultural issues, which we’ve talked about in the morning already, 

they’re very much less well positioned to make the kinds of offers 

that China has made. 

So there’s an unintended consequence here of the depth of China’s WTO commitments, which is that they have placed China in 

the position to offer a fairly substantial set of concessions to Southeast Asia in a way that they wouldn’t have been in the absence of 

such earlier commitments. 

So what’s going on here? In the first instance this has to be seen 

in a political light. China has had a number of outstanding issues 

of concern with its southern neighbors or, rather, the southern 

neighbors have had substantial concerns about China’s projection 

of force, particularly in the South China Sea. Susan Shirk will be 

talking about those issues later in her testimony. And, of course, 

there are ongoing concerns about the Chinese Diasporas and how 

those are treated and how they might affect politics in the region. 

63 

With respect to the economic potential, there’s about a $70 billion 

two-way trade between ASEAN and China. China runs a pretty 

significant deficit with the ASEAN region, but the growth has really been spectacular. But I would argue, that the real game in these 

arrangements has to do with investment. The Southeast Asian 

countries are looking to attract investment in the region. They’re 

looking at China as a possible investor in Southeast Asia in the future as it has been in Hong Kong. But most significantly they are 

seeking to attract third-party investment from countries like the 

United States, Europe, Japan, the newly industrializing country. 

They would like Southeast Asia to become a staging area for building cross-border production networks into China. 

And that’s an area in which the U.S., I think, can quite substantially benefit from these agreements. 

So what are the risks and opportunities of these sorts of arrangements? Well, of course, they can be discriminatory. That’s the concern of any preferential agreement, a concern that these might 

turn into kind of a closed block from which the United States 

would be excluded. Our view is that that’s unlikely to happen. The 

U.S. market is still very large. Our leverage is large with these 

countries, and we think that that gives us substantial capacity in 

negotiating our own agreements with countries in the region. Moreover, I think the NAFTA model shows, such agreements are in no 

way incompatible with continuing and locking in multilateral commitments. 

And, finally—and this has been a recurrent theme of other testimony as well U.S. networks that are already in Southeast Asia are 

likely to be substantial beneficiaries of this agreement when and 

if it comes to fruition. 

We see groups like the ASEAN U.S. Business Council are strongly supportive of this set of negotiations and seek to benefit from it. 

That said, I think it’s prudent for the U.S. to have a strategy, 

a kind of forward strategy to guarantee that these arrangements 

don’t prove discriminatory or exclude the United States. And in 

large part that’s what the administration’s ASEAN initiative is 

about, which is to push for bilateral trade agreements with willing 

partners, such as Singapore and Australia, that can serve as an offset or reduce any discriminatory effects that these agreements 

might have. We think that these agreements are worthwhile in 

showing our strategic commitment to Southeast Asia, both politically, as well as economically. They’re only going to work, however, 

if we choose countries that are willing to make serious agreements, 

as Australia and Singapore have been and Thailand appears to be. 

And over the longer run, we need to revive APEC process to make 

sure that the WTO, as an overarching umbrella will serve as a disciplining mechanism on these agreements so they don’t turn in a 

discriminatory direction. That’s my eight minutes, Mr. Chairman. 

So thanks very much for giving me the opportunity to speak before 

you today. 

[The statement follows:] 

64 

Testimony of Richard Feinberg and Stephan Haggard 

Graduate School of International Relations and Pacific Studies 

University of California, San Diego 

Regional Integration in the Asia-Pacific:Implications for U.S. Policy 

A significant development in the trade policy of the Asia-Pacific is the proliferation of preferential trade agreements. The new wave of bilateral and regional agreements is particularly striking because of the participation of the three largest Asian 

economies: Japan, Korea and China. Following a brief overview of recent developments, we address three questions: 

• What accounts for this shift toward regionalism? 

• What potential benefits and risks does this new Asian regionalism pose to U.S. 

economic and security interests in the Asia-Pacific? 

• How should the U.S. respond? 

The Turn toward Regionalism in the Asia-Pacific 

Growing intra-regional trade in East Asia has been driven largely by robust economic growth, unilateral economic reforms, and market forces. Cross-border production networks led by American, Japanese and Chinese multinationals have played 

a major role in this regard. Formal intergovernmental agreements have been of distinctly secondary importance. By contrast to Europe or the Western Hemisphere, 

Asia has been slow to develop intra-regional institutions. 

In the last five years, however, Asia has seen a rush to regionalism. An overview 

of the most important recent trade agreements in the Asia Pacific and their current 

status is contained in Appendix Table 1. 

These initiatives evolve around five distinct geographical axes: 

• In Northeast Asia, Korea and Japan have initiated negotiations on a free trade 

agreement, raising the question of whether a wider sub-regional arrangement 

might evolve. 

• Korea, Japan and other countries have sought negotiations with pivotal Latin 

American countries, motivated in part by an interest in gaining access to the 

North American Free Trade Area (NAFTA) and/or the prospective Free Trade 

Area of the Americas (FTAA). 

• China, Korea and Japan have entered negotiations with Southeast Asian countries, both as a group through the Association of East Asian Nations (ASEAN) 

and with individual countries. The China-ASEAN Free Trade Agreement is the 

most advanced of these initiatives. 

• Asian countries collectively, though the Asia-Europe Meeting (ASEM), and bilaterally have pursued trade agreements with the European Union (EU) and 

the European Free Trade Area (EFTA). 

• Finally, the United States has ratified a Free Trade Agreement (FTA) with 

Singapore, entered into negotiations with Australia and Thailand, and proposed 

a broader Enterprise for ASEAN Initiative (IEA). 

Precursors to the new Asian regionalism can be found in the Australia-New Zealand Closer Economic Relations Trade Agreement (1983) and the Association of 

Southeast Asian Nations Free Trade Area (AFTA, 1992). But the new wave of regionalism was set off by Singapore, Japan, and Korea, three countries that had long 

maintained a strong principled commitment to multilateralism. Singapore negotiated a bilateral FTA with New Zealand in 1999 (effective 2001) that included not 

only trade in goods and services but investment and government procurement as 

well. Japan’s first bilateral agreement was reached with Singapore in January 2002 

and went into effect in November (the Japan-Singapore Economic Partnership 

Agreement, JSEPA). Notably, this agreement largely excluded the contentious agricultural issues that were to hamper subsequent Japanese efforts in Southeast Asia, 

but it did include a national treatment provision with respect to investment. Japan 

has subsequently pursued negotiations with Mexico and Chile, two pivotal Latin 

American countries. Korea’s first FTA was with Chile. Finalized in February 2003, 

ratification has been delayed because of resistance from farmers, but it is likely to 

be passed by the Korean National Assembly soon. 

In Northeast Asia, an FTA between Japan and Korea would be a major development. A joint study group on a Korea-Japan FTA concluded almost two years of preparatory work in October 2003, and negotiations are now beginning in earnest with 

the stated intention of reaching a final agreement by 2005. Wider regional integration in Northeast Asia appears unlikely to develop in the near term. The Chinese 

have not shown an interest in negotiating an FTA with either of the other major 

65 

powers, despite the rapid market-driven growth of trade, investment and other 

forms of economic cooperation between China and Korea in particular. The Chinese 

stance could change pending a successful settlement of the North Korean nuclear 

issue, but at present a formal Northeast Asian economic agreement seems an unlikely prospect. 

A complex web of negotiations has emerged between Northeast and Southeast 

Asia. As early as 1998, Kim Dae Jung and the ASEAN Secretariat advanced the 

idea of forming an East Asian FTA consisting of the ‘‘ASEAN+3’’ or APT: ASEAN 

plus China, Japan and Korea. In 1999, the ASEAN+3 issued a Joint Statement on 

East Asian Cooperation that committed the group-albeit vaguely-to a dialogue on 

economic, political and social issues. These ideas were surprisingly similar in 

scope—although not in spirit—to a 1990 proposal by former Malaysian Prime Minister Mahathir for an East Asian Economic Grouping (EAEG) that self-consciously 

excluded the United States. 

The prospects for region-wide economic cooperation along these lines were preempted, however, by Zhu Rongji’s surprising proposal in November 2000 for a 

China-ASEAN FTA, which, depending on the precise timing of concessions, would 

grant Southeast Asian countries preferential access to the China market as China’s 

WTO concessions are phased in. It took two full years to finalize a framework agreement, and negotiations on a number of components of the agreement remain to be 

finalized. ASEAN caution has been driven by anxieties about China’s growing economic and geopolitical influence in the region, particularly with respect to ASEAN’s 

newest members (Vietnam, Myanmar, Laos and Cambodia), and by resistance from 

business sectors vulnerable to Chinese competition, Nonetheless, the framework 

agreement signed in November 2002 had a number of striking features: 

• The agreement covers not only trade in goods, but trade in services and investment as well. 

• The agreement aspires to conform with Article XXIV of the GATT/WTO which 

requires that FTAs free ‘‘substantially all’’ trade. The very concessions that 

China made in the context of its WTO accession negotiations with the United 

States had the unintended consequence of positioning it to make substantial offers in its negotiations with ASEAN, for example on agriculture. 

• China offered a number of ‘‘sweeteners’’ in order to allay ASEAN concerns, including an ‘‘early harvest’’ provision granting a quick reduction of tariffs on a 

number of items as well as preferential treatment of the new, least-developed 

ASEAN members. 

The Chinese initiative was a setback for Japan and Korea. Japan was quick to 

respond with initiatives of its own in the form of a proposed Closer Economic Partnership (CEP) with ASEAN that would cover not only trade and investment but also 

science, technology, education, and tourism. Korea was somewhat more circumspect, 

also signaling its intent to negotiate a framework agreement but admitting that agriculture posed a challenge to a bull-blown FTA. As Japan’s proposals wound 

through expert group meetings in 2003, Tokyo also initiated discussions with the 

Philippines and Thailand, suggesting that its framework approach did not preclude 

the pursuit of bilateral agreements; it is quite likely that Korea will pursue this 

strategy as well. 

Finally, brief mention should be made of the prospects for what might be called 

‘‘Greater China’’ agreements. In June 2003, China and Hong Kong reached a Closer 

Economic Partnership Agreement (CEPA) that put zero tariffs on 270 products 

meeting rules of origin requirements, opened 17 service sectors to investment by 

Hong Kong firms, and promised cooperation on measures to facilitate trade and investment. Taiwan quickly rejected the suggestion that the CEPA provided a model 

framework for cross-Straits economic relations, which have boomed despite the absence of any legal framework. But the announcement of the China-ASEAN initiative 

pushed Taiwan to form its own task force on FTAs, focusing on the United States, 

Japan, Singapore, and New Zealand, and producing a first, ‘‘test run’’ FTA with 

Panama. 

Motives and Causes 

To what do we owe this flood of initiatives? The motivations are clearly multiple, 

but we focus here on three: economic complementarities, including not only trade 

but investment; ‘‘strategic’’ motives associated with the slowing of progress in other 

trade bodies; and wider geo-political interests. 

The EconomicDimension 

Despite rapidly rising intra-regional trade flows, the economic motives behind a 

number of the proposed intra-Asian regional agreements are not self-evident. The 

66 

Chinese and Japanese economies are at very different levels of development, and 

thus highly complementary. Yet regional initiatives have not occurred along these 

lines, but rather among economies that appear, at least on the surface, to have competitive export structures, such as Korea and Japan or China and ASEAN. Analysts 

from ASEAN have continually expressed concern that China’s dynamism will push 

it out of third-country export markets and pose a direct challenge to production and 

jobs at home. 

Yet the ASEAN countries have continued to gain market share in the U.S. in critical sectors such as IT even as China has as well. Moreover, the very rapid growth 

of the China market has exerted a particular pull on the more advanced economies 

of the region-Hong Kong, Korea, Taiwan and Singapore-for which China now accounts for roughly 20 percent of exports see Figure 1). The opportunities for Hong 

Kong and Taiwan are particularly great, and are likely to deepen. China’s share of 

exports from other ASEAN countries starts from a very much lower base, but has 

grown steadily. Although China has a $120 billion bilateral trade surplus with the 

U.S., it runs substantial deficits with its neighbors, including Taiwan ($40 billion); 

Korea ($24 billion), Japan ($15 billion), Malaysia ($8 billion) and Thailand ($5 billion). Most of the deficits with China’s neighbors consist of semi-finished goods and 

components, and some share of them can be attributed to the exports of American 

multinationals from their Asian locations. 

Equally important are the opportunities that such agreements might yield with 

respect to investment and the further development of cross-border production networks. Research on the hard disk drive industry in Southeast Asia carried out at 

UCSD shows the close links between trade and investment. American firms in this 

industry maintained their competitiveness vis-a`-vis Japanese and Korean producers 

by developing cross-border production networks linking facilities in Singapore, Malaysia, Thailand and China. Hong Kong, Taiwan and Singapore all expect that bilateral agreements with China will provide advantages to them as investors in their 

own right, as valuable sites for third-party investors, and as potential recipients of 

outbound Chinese investment in the future. The Japan-Singapore Economic Partnership Agreement contained a national treatment clause and Singapore has openly 

advertised its belief that the China-ASEAN FTA will create incentive for firms both 

inside and outside ASEAN to invest there to serve the China market. The potential 

for outbound Chinese investment is already visible in Hong Kong, and the ChinaASEAN FTA will help make ASEAN an attractive site for such investment in the 

future. 

The Economic Strategy Dimension 

In addition to the economic benefits, Asian countries have been fairly straightforward about what might be called the ‘‘economic strategy’’ dimension of their pursuit of regional and bilateral arrangements. 

• Of the three major economic regions, Asia was the last to pursue preferential 

ties. As recently as 2001, only China, Hong Kong, Korea, Taiwan and Mongolia—of all 144 WTO members—were not members of some preferential trading agreement. Asian policymakers have paid close attention to the development 

of regional arrangements in Europe and the Western Hemisphere and are sensitive both to their success and to their discriminatory consequences. A number 

of recent Asian initiatives suggest efforts to dilute the discriminatory nature of 

existing regional agreements, for example, by negotiating with key Latin American countries. 

• The pursuit of more narrow regional and bilateral agreements is also a response 

to the fact that more encompassing regional efforts through APEC have not 

lived up to their promise. After the agreement in 1994 to negotiate a regionwide free trade and investment area and the success in brokering a broader liberalization in the information technology sector, APEC suffered a steady loss of 

momentum and focus. A number of APEC members resisted further liberalization in the wake of difficult Uruguay Round obligations, but the absence of clear 

leadership was clearly a factor. Underneath this weakening of APEC lie domestic political changes in key states including Australia (the return to conservative government in 1996), Japan (the stagnation of the 1990s and the objections to the 1997 Early Voluntary Sectoral Liberalization initiative), the United 

States (domestic divisions over trade policy and the rising preoccupation with 

security issues), and China (preoccupation with negotiating and implementing 

WTO accession). 

• Finally, the dramatic collapse of the Cancun ministerial has derailed the Doha 

Round, at least momentarily. Some Asian analysts, pursuing a line of thinking 

advanced by former Malaysian Prime Minister Mahathir, argue that closer 

67 

Asian cooperation would give the region more weight in global trade negotiations when they resume in earnest. 

Political and Geostrategic Motives 

In addition to these economic motives, a number of recent agreements are embedded in broader diplomatic initiatives. The Japan-Korea initiative reflects a welcome 

political rapprochement between those two countries. Taiwan’s interest in FTAs is 

tied to its ongoing efforts to break out of its political isolation. Japan’s initiatives 

toward ASEAN were clearly a response to China’s initiative. These political motives 

are important to keep in mind because they suggest that some of these initiatives 

may have weak economic underpinnings and bases of support and are thus likely 

face difficulties in negotiation and implementation; we should not assume that these 

initiatives will necessarily bear fruit. 

Beijing’s proposal of an FTA with ASEAN marks the culmination of an on-again, 

off-again effort in the post-Tiananmen period to improve relations with its Southern 

periphery. ASEAN’s response to Beijing’s crackdown was notably muted, especially 

in comparison to the American and European reactions. But Southeast Asia has had 

a number of security concerns about China, including its push to develop force projection capabilities, its behavior across the Taiwan Straits in the mid-1990s, and its 

ambitions in the South China Sea. Over the 1990s, China began to participate in 

multilateral processes and extended assistance, however modest, during the Asian 

financial crisis of 1997–98. China-ASEAN trade and investment relations are still 

relatively small, but Southeast Asian countries share with China a number of concerns about U.S. trade policy, such as the view that trade should remain distinct 

from political, human rights and labor concerns, or that these policy linkages contain a risk of disguised protection. 

Implications and Policy Response 

Critics of FTAs and bilateralism have always argued that they are fundamentally 

discriminatory and introduce unnecessary complexity into trade and investment relations through the introduction of rules that are not common across cases. Technical elements of such agreements, including particularly rules of origins and phasein provisions, make it difficult to gauge their consequences. In Asia, there is concern 

that such agreements could spell the rise of institutions that exclude the United 

States and could be a prelude to political alliances that are inimical to U.S. 

geostrategic interests. Of particular concern is the prospect that China would play 

the role that Japan was once thought to play in the region: the dynamic leader of 

a regional bloc that would ultimately use its economic clout for political and 

geostrategic ends adverse to U.S. interests. 

We share some of these concerns, but generally find them exaggerated. First, it 

is important not to confuse the rhetoric of new agreements with reality. It is one 

thing to proclaim intentions to negotiate or to sign framework agreements; it is 

quite another to negotiate details and implement them, particularly among such diverse and in many cases historically hostile countries. The 1994 APEC initiative for 

a regional FTA is salutary in this regard; the ‘‘spirit of Bogor’’ proved ephemeral, 

and lacking in conviction. Few of the many agreements that have been negotiated 

to date have been ‘‘difficult’’ in the sense of forcing hard choices on the signatories, 

as for example, the NAFTA did in North America. Those that have, such as the 

ASEAN Free Trade Agreement, have made concessions to political reality and have 

adopted a ‘‘two-tier’’ approach in which derogations have been allowed for some 

countries and sectors. A number of initiatives, such as the Korea-Chile agreement, 

have already run afoul of domestic resistance. 

Second, it is important to underscore that to the extent that such agreements do 

succeed, U.S. firms and their suppliers stand to be direct and immediate beneficiaries. U.S. firms have maintained or even regained their competitiveness in a 

number of crucial high-technology sectors by acting as ‘‘lead managers’’ in cross-border production networks that span the Asia-Pacific region. Crucial to the effectiveness of these networks are liberal investment rules, free trade, and a smoothly functioning logistics infrastructure. Continuing liberalization within Asia facilitates the 

development of these cross-border production networks, which have been crucial for 

U.S. competitiveness in Asia over the last decade. 

Third, to the extent that these agreements succeed, they can serve broader U.S. 

interests in liberalization and economic reform in Asia. As we have seen in Mexico, 

strong regional agreements can serve to support domestic reformers and lock in 

broader liberalizing initiatives. By exposing countries gradually to the requirements 

of global competition, they are driven to adopt world-class standards in areas as diverse as information technology, environmental protection and transportation secuVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00073 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
68 

rity. In this indirect manner, FTAs can be supportive, rather than undermining, of 

multilateralism. 

Finally, as Figure 1 shows, trans-Pacific trade continues to be extremely important for the Asia-Pacific. Current macroeconomic policy dictates that the United 

States will run large trade deficits and borrow extensively abroad; at the present, 

those trade deficits and foreign financing are concentrated to an important degree 

in the Asia-Pacific. As the largest market in the region, however, the United States 

also exerts a strong pull on Asian exporters. This pull provides the United States 

with leverage in the region and simultaneously deters agreements that put that relationship in jeopardy. 

Despite these considerations, it is only prudent that the United States have a political and economic strategy towards Asia that shows our continuing commitment 

to the region and guarantees that those agreements that are reached are not discriminatory in nature. 

The WTO and APEC are, in theory, ideal instruments for exercising discipline on 

such agreements. Efforts in this direction in both organizations are currently 

stalled, but should not be abandoned. 

But multilateral efforts are not incompatible with regional ones. The Bush administration has made ‘‘competitive liberalization’’ through FTAs a central organizing 

concept of U.S. trade policy. Singapore and Chile were first in line, negotiations 

have been completed with Central America and talks are now underway or are to 

commence shortly with Australia, Bahrain, the Dominican Republic, Colombia, 

Peru, Morocco, South Africa and its neighbors, and Thailand. In these negotiations, 

the U.S. has argued for agreements that go beyond trade to include the full panoply 

of new issues that are of interest to American multinationals: services, investment 

protection, intellectual property rights, e-commerce and digital piracy. The U.S. has 

also sought to incorporate its domestic social agenda—particularly labour rights and 

environmental protection—into FTAs. 

We believe that the competitive liberalization strategy is broadly justified, as a 

means of spurring regional and ultimately global liberalization, showing U.S. commitment to the Asia Pacific and neutralizing the discriminatory components of 

intra-regional efforts. For such a strategy to be successful, however, several further 

considerations are necessary. 

• The United States should push for cutting edge agreements where possible, as 

has been done in the case of Singapore, since they have the benefit of establishing useful precedents. 

• FTAs can be used to reward reformers and to promote democratization. The 

U.S. is correct to have selected Thailand, as opposed for example to Malaysia 

or the Philippines, as the first prospective ASEAN FTA partner after Singapore. 

• For such negotiations to be meaningful, fair and successful, the U.S. must be 

prepared to confront its own domestic protectionists in order to make reciprocal 

concessions, including in sensitive agricultural areas that are of continuing interest to a number of Southeast Asian countries. 

• The erosion of the Congressional consensus behind free trade poses a threat to 

further trade policy liberalization of any kind. The Executive Branch needs to 

rebuild a wide bi-partisan base that recognizes U.S. economic, political and geostrategic interests in FTAs. This will require, among other things, that the 

broader public come to view trade agreements as being fair and equitable, and 

as promoting trade and investment patterns that spread the benefits of 

globalization more equally both at home and abroad. 

• An important component of such a strategy is to focus aggressively and persistently on enforcement and monitoring of existing agreements, including China’s 

WTO commitments, to ensure their credibility and to increase U.S. access and 

exports to the region 

Conclusions and Recommendations 

• Intra-Asian economic regionalism is being driven primarily by market forces 

and by the rapid growth of the Chinese economy as a regional development 

pole. This process will persist so long as the Chinese and other regional economies continue on their rapid growth trajectory. 

• Asia is at an early stage in negotiating and implementing regional trade agreements. We should not confuse proclamations of intentions with assured outcomes. Many of the announced FTA initiatives may never mature. 

• The United States should not be opposed to Asian regionalism per se. Ideally, 

it can spur regional efficiency and growth, help stabilize geopolitical relations, 

and act as a spur outside the Asia-Pacific to a resumption of multilateral negotiations through the WTO. 

69 

• Intra-regional trade agreements must also be understood in the context of the 

rapid development of cross-border production networks in which U.S. firms are 

key players. U.S. firms stand to gain from agreements that appear on the surface to be ‘‘intra-Asian.’’ 

• However, the U.S. should be concerned about the potential for distortions and 

discrimination inherent in preferential trading agreements. 

• In the continued absence of significant trade and investment liberalization in 

the World Trade Organization (WTO) and the Asia Pacific Economic Cooperation (APEC) forum, as a guarantee that regional agreements do not exclude the 

United States, and to maintain a U.S. economic and geopolitical presence in the 

Asia Pacific, the U.S. should continue to pursue its own regional FTA strategy 

with willing and carefully selected partners. The U.S. should avoid a panic-driven proliferation of FTAs of questionable economic depth or political value. 

• This strategy is only likely to work, however, if the content of these agreements 

is genuinely reciprocal. 

• Over the longer run, the U.S. should strive to make the WTO and APEC into 

instruments for disciplining regional trading agreements, to minimize their discriminatory nature and to render them as consistent as possible with global 

norms. 

Appendix 

Table 1: Select Preferential Trade Agreements in the Asia-Pacific 

(Status as of February 2004) 

Country/Grouping Partner/partners Status 

ASEAN ASEAN Proposed Common Market 

China Framework Agreement signed 2002 

EU Trans-Regional EU-ASEAN Trade Initiative, 

2003 

Japan Framework Agreement signed 2003 

Korea Proposed 

United States Enterprise for ASEAN Initiative, 2002 

China ASEAN Framework Agreement signed 2002 

Hong Kong Closer Economic Partnership Agreement, 2003 

Malaysia Under negotiation 

Singapore Under negotiation 

Japan ASEAN Framework Agreement signed 2003 

Korea Under negotiation 

Mexico Under negotiation 

The Philippines Under negotiation 

Singapore Economic Partnership Agreement, 2002 

Thailand Under negotiation 

Korea Chile Pending ratification 

Mexico Negotiations suspended, 2003 

Japan Under negotiation 

Singapore Proposed 

Malaysia China Under negotiation 

Japan Under negotiation 

United States Proposed 

The Philippines Japan Under negotiation 

United States Proposed 

Singapore Australia Agreement signed, 2003 

Canada Under negotiation 

China Under negotiation 

EFTA Agreement signed, 2003 

EU Proposed, rejected by EU 

India Under negotiation 

Japan Economic Partnership Agreement, 2002 

Korea Under negotiation 

New Zealand Agreement signed, 2000 

New Zealand and 

Chile 

P3FTA proposed 

Sri Lanka Proposed 

Taiwan Guatemala Under negotiation 

Panama Agreement signed, 2003 

70 

Table 1: Select Preferential Trade Agreements in the Asia-Pacific— 

Continued 

(Status as of February 2004) 

Country/Grouping Partner/partners Status 

Thailand Australia Preliminary agreement signed, 2003 

China Agreement signed, 2003 

India Agreement signed, 2003 

Japan Under negotiation 

New Zealand Under negotiation 

Singapore Under negotiation 

United States Under negotiation 

United States ASEAN Enterprise for ASEAN Initiative, 2002, 

Australia Under negotiation 

Malaysia Proposed 

The Philippines Proposed 

Thailand Under negotiation 

Figure 1 

Vice Chairman D’AMATO. Thank you very much, Dr. Haggard. 

And thank you for revealing the San Diego line today here for the 

Commission. Now we’ll just move right on to Dr. Hanson. 

STATEMENT OF GORDON H. HANSON 

PROFESSOR ECONOMICS 

GRADUATE SCHOOL OF INTERNATIONAL RELATIONS AND 

PACIFIC STUDIES 

UNIVERSITY OF CALIFORNIA, SAN DIEGO 

Dr. HANSON. And more of the same. 

Vice Chairman D’AMATO. More of the same. 

Dr. HANSON. I’m another San Diego representative. 

The high level of discussion in this morning’s panel actually covered a lot of what I had included in my written remarks. And so 

what I would like to do is to speak extemporaneously and to try 

and push that discussion forward. Commissioner Mulloy put two 

visions of the global economy on the table: One by Paul Craig Roberts which says that new forms of trade are a threat to the United 

States; another by Gregory Mankiw, the chairman of President 


Insert feinberg.eps
71 

Bush’s Council of Economic of Advisors, which says that international outsourcing and the new business models that we are seeing in operation present opportunities for gains to the U.S. economy. The discussion about China is really a debate about whether 

the new business model that we’re seeing is something that is of 

benefit to the country as a whole and also about the distribution 

of those benefits. To very quickly sum up, what we’ve seen in 

China is a country that has been rapidly incorporated into global 

production networks, which are formed by multinational firms. 

This business model is based on the idea of taking production, 

breaking it into stages and locating each stage where it can be 

done at least cost. 

So where the U.S. typically fits into this production chain is in 

the more skill- and technology-intensive activities. So that includes 

research and development. That also includes a whole range of 

business services that get goods to consumers and also involves 

production of more sophisticated components. 

Where China fits into that production chain is primarily in a 

pretty narrow task of processing parts and components that have 

been produced in the rest of the world. 

Now, given that China comes at the end of that production line, 

it gets to some extent unfairly singled out as being the culprit in 

the impacts that this model of global production networks has had 

on the U.S. economy. But just to reiterate a couple of key points. 

55 percent of China’s exports are exports that are based on processing parts and components that have been made in the rest of 

the world. What that means is that those goods that arrive from 

China in the United States embody not all that much value added 

from China. Research that I’ve done with Robert Feenstra at the 

University of California at Davis suggests that China’s contribution 

in terms of value added to those processing exports it sends to the 

rest of the world is only 36 percent. That means that nearly twothirds of the value added in those processing exports that China is 

sending abroad represent goods and services that have been manufactured elsewhere. Now, let’s come to the key question of interest. 

What does this mean for the U.S. economy? 

In work that Professor Feenstra and I did—which is not mentioned in my written testimony, but which I’m happy to make 

available to the Commission—we examined the labor market consequences of international outsourcing for the U.S. economy, focusing on U.S. manufacturing in particular. 

And in designing that study, one important thing for us to incorporate was the fact that greater opportunities for trade is not the 

only, and by no means the most important, shock that has hit the 

U.S. economy and U.S. manufacturing in particular over the last 

two decades. 

The rapid pace of technological development has also meant tremendous changes in the organization of work. 

Our challenge in this study was to try and estimate what’s the 

relative contribution of these new forms of technology versus these 

new forms of trade in international outsourcing for the wages that 

manufacturing workers earn. We’re, in particular, interested in trying to understand how the wages of white-collar, more skilled 

72 

workers had changed relative to the wages of blue-collar workers 

with—who typically have lower education levels. 

The key finding in that study is that outsourcing does tend to 

benefit white-collar workers more than blue-collar workers. But the 

impact of international outsourcing is much smaller than the impact of technological change itself. 

So as we think about the challenges that are facing U.S. manufacturing, trade is just one of those challenges. 

And we’ve got firms that are trying to deal with a dramatically 

changing production environment. And those changes create opportunities for the U.S. economy to move into new goods, into new activities, and that—that’s the basis for—that is the inaction and the 

basis for productivity growth on which increases in the standard of 

living of our economy are based. 

But those changes, be they in the form of technological change 

or in the form of increased international outsourcing, have costs. 

Commissioner Becker talked about the 400,000 jobs that are at 

stake if the multifiber arrangement is phased out as is planned. 

Those dislocation costs are real, but as we think about visions for 

the future of the American economy, you can—you can think about 

one vision, which delays that adjustment yet, further into the future. 

In some sense thinking about those 400,000 jobs that are at 

stake, one question we might want to ask ourselves is, why have 

we left the multifiber arrangement in place so long? Why have we 

exposed so many workers to the risk of competition from low-wage 

countries throughout the world? 

The problem is not going to get better. The problem is only going 

to get worse over time. The longer we delay adjustment, the more 

costly it is going to be to those individual workers, to the communities and the regions in which they live to incorporate them into 

other sectors. Let me make two final points in closing. One is in 

terms of thinking about the employment effects of changes in trade 

and technological change. 

What research has overwhelmingly showed is that the long-term 

consequences on the employment level is virtually nonexistent. 

Workers get reemployed. It can take a while. It can be painful. It 

often happens in different industries, in different communities and 

in different regions. And that is where the painful adjustment occurs, in that process of moving workers and workers moving themselves from one sector and one region to another. The final point 

I wanted to make related to thinking about an alternative vision, 

one that doesn’t prolong adjustment, but thinks about how the U.S. 

is going to fit into this global production chain in the future. And 

that’s one in which we continue to develop our capacity to lead the 

world in research and development and producing sophisticated 

componentry. The basis for that, very simply, as Dean Cowhey suggested this morning, is to educate our way out of having to compete 

with low-wage—to low-wage countries. 

Two instructive examples come in the form of Hong Kong and 

Taiwan. These two countries face a much more direct threat in 

terms of jobs from China than the U.S. has. 

How have they fared? Tremendous reallocation out of manufacturing into activities that’s been made possible by very high levels 

73 

of investment in human capital. Hong Kong’s manufacturing sector 

went from 25 percent of GDP in 1980 to about 4 percent per day— 

today. Those workers are now employed in business services, making international trade possible. 

So the adjustment is feasible, but the basis in all of these examples is high levels of investment in human capital. 

[The statement follows:] 

Prepared Statement of Gordon H. Hanson, Ph.D. 

Professor of Economics, Graduate School of International Relations and 

Pacific Studies 

University of California, San Diego 

1. Introduction 

In the last two decades, China has emerged as an export powerhouse. The country 

has become a major global player in a wide range of industries. China’s export success began with simple consumer products, such as apparel, footwear, and toys, and 

has since expanded to include electronics and other more technologically advanced 

products. The rapid growth in China’s exports has caused concern in many quarters. 

The size and accelerated expansion of China’s economy have created the perception 

that the country will come to dominate much of global manufacturing, forcing painful adjustments on the part of its trading partners. 

In my testimony today, I will argue that concerns about China’s export prowess 

are exaggerated. China’s export growth, while impressive, has been made possible 

by an equally impressive expansion of imports of business services and intermediate 

inputs from many countries, including the United States. A substantial fraction of 

China’s trade is related to its participation in global production networks. In these 

networks, which are organized by multinational enterprises (some of which are 

headquartered in the U.S.), China’s primary role is to assemble final goods that 

have been designed in other countries out of inputs that have been produced in 

other countries. Thus, a substantial fraction of China’s exports embody goods and 

services produced elsewhere. 

Below, I will describe the structure of China’s exports with particular attention 

to the role of production networks in shaping how China interacts with the rest of 

the world. I will identify the fraction of China’s exports that are associated with the 

specialized task of assembly, the role of multinational enterprises in China’s export 

production, and the fraction of China’s exports that are attributable to value added 

in China versus other countries. 

2. Export Processing in China 

Over the last several decades, much of the developing world has adopted trade 

policies that favor export production. Typically, the early periods of export-led development involve export processing. In this arrangement, firms import parts and components from abroad, process these inputs into finished goods, and then export the 

final products. In the 1970s, Hong Kong, Singapore, and Taiwan assembled and exported footwear, clothing, and other consumer goods (Findlay and Wellisz, 1993). In 

the 1980s, China, Mexico, and much of Southeast Asia developed extensive export 

processing operations (Grunwald and Flam, 1985; Yeats, 2001). And in the 1990s, 

Central America, Eastern Europe, and South Asia joined the fray. 

2.1 Policy Regimes for Export Processing 

Export processing plays a major role in China’s foreign trade. (All trade data for 

China are for the mainland and exclude Hong Kong. Below, we provide data on 

trade between Hong Kong and the mainland.) Table 1 shows that over the years 

1997–2002, processing exports accounted for 55.6% of China’s total exports. Export 

processing in China is broadly similar to that in other countries. Inputs used in export processing are imported duty-free (as are any investment goods used in export 

processing) as long as these goods are only used to produce exports. Since the early 

1980s, China has permitted foreign ownership of export processing plants. It stipulates that all processing plants (whether Chinese or foreign owned) operate according to one of two regimes: a pure-assembly regime, in which a foreign buyer supplies 

a plant in China with inputs and hires the plant to process them into finished 

goods, all the while retaining ownership over the inputs; and an import-and-assembly regime, in which a plant in China imports inputs of its own accord, processes 

them, and sells the processed goods to a foreign buyer. 

74 

• The Pure-Assembly Regime: In this arrangement, a foreign firm supplies a factory in China with materials from abroad (Naughton, 1996). The factory in China, 

whose role is relatively passive, receives orders from and delivers processed goods 

to the foreign client, who then sells the goods outside China. While the factory takes 

possession of the imported materials during processing, the foreign firm retains 

ownership over them. The foreign firm pays the factory in China a fee for its processing services. To obtain clearance from Chinese customs to import materials and 

to export processed goods, the terms of the transaction between the Chinese factory 

and the foreign firm must be stipulated in a written contract and presented in advance to Chinese customs officials for approval. Legally, the processing factory may 

use imported materials for the sole purpose of meeting its obligations to the foreign 

client. 

• The Import-and-Assembly Regime: In this arrangement, the processing factory 

in China plays a more active role. Table 1 shows that this regime is the more common form of export processing, accounting for 70.7% of processing exports over the 

1997–2002 period. The factory imports materials of its own accord and takes ownership of these materials during processing. It may broker deals to process goods for 

multiple foreign firms (World Bank, 1994). Thus, the factory in China controls both 

the import of inputs and the export of processed goods (though usually not the marketing and sale of the good to end users). Legally, Chinese customs treats processing 

plants under this regime as bonded warehouses—facilities that are permitted to import inputs duty free under the proviso that they export all output (bonded goods 

cannot be transferred to another party without the approval of Chinese customs). 

To become a bonded warehouse, a plant must apply to the Chinese government and 

have warehouse facilities and accounting personnel that meet government standards. Under either export processing regime, exporters are required to submit 

monthly reports on the status of their contracts and to verify that the contract has 

been completed within a month of having exported the finished goods. 

2.2 Foreign Investment and Export Processing 

Foreign-invested enterprises (FIEs) play a major role in China’s overall trade, and 

in China’s processing trade in particular. Table 1 shows that over the period 1997– 

2002 FIEs accounted for 62.8% of China’s total processing exports. (The Chinese 

government recognizes two categories of FIEs, wholly foreign-owned enterprises and 

equity joint ventures in which a foreign interest has at least a 25% ownership stake. 

One question is whether a 25% ownership share gives a foreign party effective control over a processing factory. Standard definitions of whether an enterprise is foreign controlled set a lower ownership threshold, such as 10% in the case of the U.S. 

government. Thus, I classify both wholly-owned enterprises and equity joint ventures as FIEs.) 

Export processing began to take off in China in the late 1980s. The pioneers in 

the sector included Hong Kong trading companies that set up processing plants 

across the border from Hong Kong in Guangdong Province and used Hong Kong as 

a base from which to manage their operations (Sung, 1991). Hong Kong continues 

to mediate a large fraction of China’s processing trade. Table 1 shows that over the 

sample period, 45.9% of China’s processing exports were re-exported through Hong 

Kong. 

Another reason—besides proximity to Hong Kong—that coastal China has developed more export processing than the rest of the country is that over the last two 

decades trade policies have varied substantially across regions of the country. In the 

early stage of China’s economic opening, the government permitted foreign trade 

and investment only in Special Economic Zones (SEZs) located in the southern 

coastal provinces of Guangdong and Fujian. In the mid to late 1980s, the government expanded the number of regions in which foreign trade and investment were 

permitted. By the 1990s, foreign trade and investment were allowed (subject to government approval) throughout the country (Demurger et al, 2001). Still, much export activity continued to be concentrated in SEZs. Advantages to being in an SEZ 

may include expedited treatment by customs of imported inputs and exported outputs, more freedom to import or export goods directly rather than through stateowned foreign trade corporations, greater opportunities to retain foreign exchange 

earnings, and access to various types of tax incentives. There are is also a separate 

court system set up to handle civil and commercial legal cases in trade zones (Wang, 

2000). 

SEZs have been succeeded by second and third generation trade and development 

zones, including bonded areas, Economic and Technological Development Areas, and 

Hi-Technology Development Areas. These zones are managed by provincial governments and so may exhibit regional variation in their organization and effectiveness. 

75 

2.3 Value Added in Export Processing in China 

Given the importance of imported inputs in China’s processing exports, the total 

value of China’s exports overstates the Chinese content of these goods (i.e., the fraction of these exports that represent value added in China). In recent work (Feenstra 

and Hanson, 2003), I have estimated the fraction of China’s processing exports that 

is attributable to Chinese value added. An initial measure of value-added in Chinese 

export processing is the difference between the value of processing exports and processing imports (relative to processing exports). As shown at the bottom of column 

(3) in Table 2, average value-added is 36% over all products and years 1997–2002. 

Thus, nearly two-thirds of China’s processing exports embody part, components, and 

other intermediate inputs produced in other countries. 

There is considerable variation in processing trade and in Chinese value added 

in export processing across industries and provinces in China. In Table 3, I summarize the industry variation at the level of one-digit SITC (Standard Industrial Trade 

Classification) industries. (It is not possible to measure value added by individual 

products—i.e., within one-digit industries—since it is not known what other products they use as inputs.) To show how electronics differs from other industries, I 

separate out SITC 7, which is machinery and transport equipment and which includes computers and other electronics products, from other SITC categories. To 

show how these industries differ between the more-developed coast and the less-developed interior, I show value added separately by province. For the coastal provinces, there are roughly equal processing exports within SITC 7 and outside this 

category. But the inland provinces have about four times as much processing exports outside of this category. Thus, production of more technologically sophisticated 

exports—computers, electronics, and other machinery—is concentrated in coastal 

China. The most important sector for the inland provinces is SITC 8, which includes 

apparel, footwear, toys, and other labor-intensive industries. 

Average value-added estimates by 1-digit SITC industries are shown in column 

(3) of Table 2. The industries with the greatest processing exports are SITC 6 (manufactured goods), SITC 7 (machinery and transport equipment, including electronics) and SITC 8 (miscellaneous manufactured goods, including apparel, footwear, and toys). There is relatively low value-added of 16% in SITC 6 and 8, and 

higher value-added of 55% in SITC 7. As described by Yeats (2001), SITC 7 includes 

a number of individual products and their parts, such as: automobiles and their 

parts; computers and their parts; various types of machinery and their parts; etc. 

Thus, value added in China appears to be higher in electronics and other technologically more advanced goods than in apparel, footwear, toys, and other more laborintensive goods. 

3. Hong Kong’s Role in China’s Exports 

Beyond its specific involvement in export processing in China, Hong Kong plays 

an important role in distributing goods produced in China. Since the early 1980s, 

Hong Kong has become increasingly specialized in the re-export of Chinese goods. 

In this arrangement, traders in Hong Kong import goods from China and then distribute them to destination countries. Over the period 1988–1998, 53% of total Chinese exports were shipped through Hong Kong in this manner. Goods that are reexported are not subject to substantial manufacturing operations in Hong Kong, but 

are typically subject to simple processing activities, such as sorting or packaging, 

or service activities, such as marketing or transport. Hong Kong traders provide a 

range of important intermediation services to the mainland, including finding foreign buyers, sorting and grading goods according to quality, labeling and packaging, 

and coordinating processing in China with processing in other countries (Naughton, 

1997; Feenstra and Hanson, 2002). (Hong Kong also intermediates exports to China 

from the rest of the world. In 1996, re-exports by Hong Kong accounted for 47% of 

China’s total imports (Sung, 1997).) 

In re-exporting Chinese products, Hong Kong adds value to these goods. When the 

U.S. tallies total imports from China, it adds to direct imports from China imports 

of Chinese goods re-exported by Hong Kong. But this calculation overstates exports 

by mainland China, since a fraction of the value of Chinese goods that Hong Kong 

re-exports represents the value of intermediation services provided by traders in 

Hong Kong. Recent estimates, reported below, suggest this value added by Hong 

Kong is substantial, totaling nearly 25% of the total value of Chinese goods re-exported by Hong Kong. 

3.1 History of Hong Kong-China Trade Relations 

Hong Kong’s position as an entrepoˆt dates back to China’s cession of the Island 

to Britain in 1842 (Sung, 1991). Trade between Hong Kong and China was mostly 

dormant during the rigid Chinese communist rule of 1949 to 1978. The opening of 

76 

China to foreign trade and investment in the late 1970s has lead to dramatic 

changes in both economies. Before 1980, Hong Kong grew largely through producing 

and exporting labor-intensive manufactures, such as apparel, textiles, footwear, 

toys, and consumer electronics (Findlay and Wellisz, 1993). Learning about the production and marketing of these goods, which also account for a large fraction of China’s current exports, may have helped Hong Kong become a middleman for global 

trade (Hamilton, 1999). 

Since 1980, Hong Kong has begun to specialize more heavily in business services, 

particularly those related to trade and investment in China. As described in the last 

section, China’s export manufacturers are concentrated in southern coastal provinces, especially Guangdong which borders Hong Kong (Sung, 1997). Over the last 

two decades, many Hong Kong manufacturing firms have moved their production 

facilities to Guangdong, which they manage from headquarters in Hong Kong. Hong 

Kong firms typically supply plants in China with raw materials and often ship the 

goods through Hong Kong for inspection, finishing, or packaging before exporting 

them to a final destination (Sung, 1991). As Hong Kong has shifted production to 

China, manufacturing has become a much less important part of the Hong Kong 

economy, declining from 24% of GDP in 1980 to 6% of GDP in 1998. China’s economic opening thus has contributed to a dramatic reorientation of Hong Kong’s 

economy from manufacturing to the provision of business services related to international trade. 

Why has Hong Kong succeeded in playing such an important role in China’s exports? Hong Kong traders appear to have an informational advantage in trade between China and the rest of the world. This advantage may be due to Hong Kong’s 

proximity to mainland China, especially the southern coastal provinces where export 

production is concentrated (Sung, 1991). Hong Kong traders have developed specialized operations to find Chinese producers who can meet foreign quality standards 

and to locate buyers for Chinese goods. As middlemen, traders may earn informational rents—that is, a profit margin associated with intermediating China’s exports. This profit margin shows up as a markup on Chinese products re-exported 

by Hong Kong. Below, I report estimates of these markups. 

3.2 Sectoral and Geographic Patterns in Hong Kong Re-Exports of Chinese 

Goods 

Table 4 shows the distribution of direct Chinese exports and Hong Kong re-exports of Chinese goods across one-digit SITC industries. Re-exports are concentrated 

in SITC 8, light manufactured articles, whose major sub-sectors are apparel and 

footwear. This industry accounts for 57.5% of total re-exports over the sample period 

(where shares are stable over time). Machinery and transport equipment (SITC 7) 

and manufactured materials (SITC 6), which includes textiles, are also important 

sources of re-exports, accounting for 22.4% and 14.0% of total re-exports respectively. SITC 7 and 8 are the two industries in which re-exports account for the largest fraction of total exports, with re-export shares of total Chinese exports equal to 

69.5% and 70.1% respectively. These are also the two industries in which outwardprocessed goods and exports by FIEs dominate China’s shipments to Hong Kong. 

In contrast to re-exports, direct Chinese exports are spread relatively evenly 

across industries. Light manufactured articles (apparel, footwear) account for only 

27.9% of direct exports. Food, mineral fuels, chemicals, and crude material, which 

account for very small fractions of total re-exports, are relatively large sources of 

direct exports. In all industries outward processing and exports by FIEs account for 

a lower fraction of China’s direct exports than of China’s exports to Hong Kong. (It 

is important to note that some firms registered as FIEs in China do so only to receive favorable tax treatment, and achieve this by having a partner in Hong Kong. 

This so-called ‘‘round tripping’’ creates an artificial correlation between FIE activity 

and trade through Hong Kong.) 

To examine the distribution of exports across sectors in more detail, Table 5 lists 

the two-digit SITC industries that account for an average of at least 2% of either 

total direct exports or total re-exports over the sample period. Apparel and textile 

yarn fabrics are major sources of both direct exports and re-exports. Industries 

which are an important for re-exports but not direct exports include toys and games, 

televisions and radios, footwear, electrical machinery, luggage, and office machines. 

These are also industries for which outward processing dominates China’s shipments to Hong Kong. Industries which are important for direct exports but not reexports include fuel oils, vegetables and fruit, fish, and inorganic chemicals. 

It appears that the industries that rely most heavily on re-exports are those that 

produce differentiated products, such as apparel, footwear, toys, and consumer electronics. For many differentiated goods product quality is often difficult to observe 

or verify, which may create demand for traders in Hong Kong to resolve informaVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00082 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
77 

tional problems in exchange. These also tend to be goods whose production stages 

span both high-skill activities, such as product design, and low-skill activities, such 

as simple assembly, which makes them suitable for outward processing. Differentiated goods are frequently produced in small batches, which creates an incentive 

to ship through hubs, but they are also high-value-to-weight items, which offsets the 

incentive to use hubs. Additionally, apparel and textiles are subject to Multi-fibre 

Arrangement (MFA) quotas in many countries. Shipping these goods through Hong 

Kong may be a means of circumventing binding quotas on Chinese exports. 

Table 6 shows the distribution of direct exports and Hong Kong re-exports across 

regions and the average share of re-exports in total exports by region. To the extent 

information costs motivate re-exporting goods through Hong Kong, we would expect 

to see a higher fraction of re-exports going to rich regions, which have a relatively 

strong demand for differentiated goods. To the extend that transport costs motivate 

re-exporting goods, we would expect to see a higher fraction of re-exports going to 

distant regions, for which the extra distance of shipping goods through a hub would 

add relatively little to cost. 

For both direct exports and re-exports, the major destinations are, not surprisingly, the relatively large markets of North America, Western Europe, and East 

Asia. The regions for which re-exports account for most trade include the relatively 

rich and distant regions of North America (71.4%) and Western Europe (62.1%), the 

relatively rich and near region of Oceania (61.2%), and the relatively poor and distant regions of Latin America (65.0%) and Africa (49.9%). This variation in re-export 

shares across regions suggests that both information costs and transport costs may 

be important for entrepoˆt trade. 

3.3 Markups on Hong Kong Re-Exports of Chinese Goods 

Net of customs, insurance, and freight charges, Chinese goods are much more expensive when they leave Hong Kong than when they enter. For the 1988–1998 period, the average markup on Hong Kong re-exports of Chinese goods was 24%. The 

income flow from these entrepoˆt activities is large. In 1998, re-exports of Chinese 

goods equaled 47% of Hong Kong GDP. In that same year, Hong Kong markups on 

these re-exports totaled 12% of GDP, while manufacturing accounted for only 6% 

of GDP. 

Figures 1–3 present estimates for markups on Hong Kong re-exports of Chinese 

goods. Figure 1 shows the distribution of markups by year using box plots. (The 

midline in the box shows the median, the box shows the inter-quartile (25th-75th 

percentile) range, and the upper and lower horizontal lines extend to 1.5 times the 

inter-quartile range above or below the box. Individual points are observations 

above or below this range.) Median markup values range from 28% to 34% and are 

relatively stable over time. 

Figure 2 shows the distribution of markups by one-digit SITC industry. Markups 

appear to be largest for light manufactured articles (SITC 8) and machinery and 

transport equipment (SITC 7) and lowest for mineral fuels (SITC 3) and animal and 

vegetable oils (SITC 4). Figure 3 shows the distribution of markups by region. Markups appear to be highest in the rich regions of North America, Oceania, and Western Europe and lowest in the poor regions of Africa and Latin America. 

Table 7 shows Hong Kong markups on re-exports from China related to export 

processing overall and by one-digit SITC industry. The average markup for these 

goods is 17%, which is somewhat less than for China’s overall exports. Since to Figure 2, the highest markups (besides beverages and tobacco) are for SITC 7 (dominated by electronics) and SITC 8 (dominates by apparel, footwear, and toys). 

4. Conclusion 

China is portrayed in the popular press and by many politicians as an export locomotive that is on the verge of running over the manufacturing industries of the 

United States and other countries. A detailed examination of the structure of China’s export industries reveals a more nuanced picture. China’s international trade 

is an outgrowth of its participation in global production networks, within which 

China imports substantial quantities of intermediate inputs and business services 

from other countries. In recent years, around 56% of China’s total exports were related to export processing, in which China assembles inputs imported from abroad. 

Recent estimates imply that of the total value of China’s processing exports, only 

36% are attributable to value added in China. Thus, official trade statistics substantially overstate the value of China’s exports that are attributable to production in 

the country. 

Multinational enterprises, including firms based in the United States, are primarily responsible for the coordination of global production networks. In recent 

years, foreign enterprises have accounted for about 63% of China’s total processing 

78 

exports and about 40% of China’s total exports. Many of these foreign firms manage 

operates in mainland China from operations based in Hong Kong. Traders in Hong 

Kong play an important role in distributing goods produced in China to the rest of 

the world. Naturally, these traders charge for this service, and the markup they 

levy is incorporated into the reported value of China’s exports. This creates another 

source of upward bias in U.S. government statistics on China’s trade. Approximately 

24% of the value of Chinese goods re-exported through Hong Kong is attributed to 

services provided in Hong Kong. 

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Naughton, Barry. 1999. ‘‘Between China and the World: Hong Kong’s Economy 

Before and After 1997.’’ In Hamilton, ed., 1999. 

Sung, Yun-Wing. 1991. The China-Hong Kong Connection. Cambridge: Cambridge 

University Press. 

Sung, Yun-Wing. 1998. Hong Kong and South China: The Economic Synergy. 

Hong Kong: City University of Hong Kong Press. 

Wang, Kui Hua. 2000. Chinese Commercial Law. Oxford: Oxford University Press. 

World Bank. 1994. ‘‘China: Foreign Trade Reform.’’ Washington, DC. 

Yeats, Alexander J. 2001. ‘‘Just How Big is Global Production Sharing?’’ in Sven 

W. Arndt and Henryk Kierzkowski (eds.), Fragmentation: New Production Patterns 

in the World Economy, Oxford: Oxford University Press. 

79 

Table 1: Foreign Ownership, Export Processing, and Trade in China 

Year 

Processing 

Exports/ 

Total Exports 

FIE Exports/Total 

Exports 

Share in Total Processing Exports of 

Importand-Assembly 

Hong Kong 

Re-Exports 

FIE Exports 

1997 0.545 0.361 0.704 0.556 0.561 

1998 0.568 0.393 0.705 0.552 0.587 

1999 0.568 0.413 0.677 0.507 0.609 

2000 0.552 0.439 0.701 0.470 0.646 

2001 0.554 0.462 0.714 0.456 0.669 

2002 0.550 0.484 0.741 0.436 0.697 

Notes: Columns (1) and (2) show processing exports and exports by foreign-invested enterprises, respectively, 

as a share of total China exports; columns (3)–(6) show as a share of total China processing exports, processing exports under the import-and-assembly regime, processing exports re-exported through Hong Kong, and 

processing exports by foreign-invested enterprises, respectively. 

Table 2: Chinese Processing Trade by SITC Industry 

($million and percent, average 1997–2002) 

(1) 

Processing 

Exports 

($ million) 

(2) 

Processing 

Imports 

($ million) 

(3) 

Valueadded 

(percent) 

SITC 1—Beverages and tobacco 64 6 63% 

SITC 2—Crude materials, inedible, except fuels 295 4,568 63% 

SITC 3—Mineral fuels, lubricants and related materials 602 1,006 67% 

SITC 4—Animal and vegetable oils, fats and waxes 160 224 43% 

SITC 5—Chemicals and related products 2,416 11,858 67% 

SITC 6—Manufactured goods 16,081 25,750 16% 

SITC 7—Machinery and Transport Equipment 60,443 30,486 55% 

SITC 8—Miscellaneous manufactured articles 45,949 6,626 16% 

Total 128,553 82,600 36% 

Notes: See Feenstra and Hanson (2003). 

Table 3: Chinese Processing Trade by Provinces and SITC Industry 

($million and percent, average 1997–2002) 

FDI 

($bill) 

Within SITC 7 Outside SITC 7 

(1) 

Processing 

Exports 

($ million) 

(2) 

Processing 

Imports 

($ million) 

(3) 

(1)–(2) 

(1) 

(percent) 

(1) 

Processing 

Exports 

($ million) 

(2) 

Processing 

Imports 

($ million) 

(3) 

(1)–(2) 

(1) 

(percent) 

Coastal 

North 

Heilongjiang 1.3 100 77 22% 114 72 36% 

Jilin 1.1 86 34 61% 218 135 38% 

Liaoning 5.4 2,551 1,374 46% 2,645 2,249 15% 

Beijing area 

Beijing/Tianjin 9.1 4,923 2,760 44% 2,470 2,031 18% 

Hebei 2.0 98 31 69% 577 320 44% 

Shandong 8.5 1,604 811 49% 5,906 3,862 35% 

Shanghai area 

Jiangsu 14.0 7,432 3,903 47% 5,339 4,210 21% 

Shanghai 11.6 6,497 3,413 47% 5,877 4,284 27% 

Zhejiang 4.0 891 417 53% 2,826 1,622 43% 

South 

Fujian 13.7 2,325 1,143 51% 3,791 2,686 29% 

Guangdong 39.0 33,229 16,282 51% 35,670 29,033 19% 

Hainan 4.0 7.9 2.3 71% 81 57 30% 

Total coastal 113.7 59,744 30,247 49% 65,514 50,560 23% 

80 

Table 3: Chinese Processing Trade by Provinces and SITC Industry— 

Continued 

($million and percent, average 1997–2002) 

FDI 

($bill) 

Within SITC 7 Outside SITC 7 

(1) 

Processing 

Exports 

($ million) 

(2) 

Processing 

Imports 

($ million) 

(3) 

(1)–(2) 

(1) 

(percent) 

(1) 

Processing 

Exports 

($ million) 

(2) 

Processing 

Imports 

($ million) 

(3) 

(1)–(2) 

(1) 

(percent) 

Inland 

17 provinces 15.2 699 240 66% 2,596 1,554 40% 

Notes: Column (3) reports (processing exports—processing imports)/processing exports for each province, for 

SITC 7 and all other SITC. We combine Beijing and the neighboring industrial district of Tianjin, while 

Guangxi is treated as an inland province even though it has some coastline in the south of China. 

Table 4: Direct Exports and Re-exports of Chinese Goods, 1988–1998 

Year 

Total 

China 

Exports 

(billions 

US$) 

Re-Export Share of 

Total China Exports Outward 

Processing 

Share 

of 

China 

Foreign-Invested Enterprise Share of China 

Direct 

Exports 

Exports 

to 

Hong 

Kong 

Total 

Exports 

Direct 

Exports 

Exports 

to 

Hong 

Kong 

Total 

Exports 

(1) (2) (3) (4) (5) (6) (7) (8) 

88 38.7 43.1 12.8 49.7 32.1 1.2 8.5 4.7 

89 46.3 51.5 19.7 56.9 40.3 3.1 13.4 8.3 

90 55.4 55.2 21.9 58.5 43.4 4.2 16.7 10.9 

91 67.8 59.1 24.9 61.5 47.1 6.5 19.1 13.5 

92 84.7 60.1 24.8 63.1 47.9 8.6 20.8 15.2 

93 98.0 61.3 24.4 67.2 49.4 17.8 35.1 27.1 

94 120.2 57.7 27.4 62.1 47.7 19.8 35.2 28.5 

95 151.6 53.3 32.7 65.8 50.1 21.9 40.6 31.3 

96 161.0 49.8 38.1 76.0 54.3 31.3 49.8 39.0 

97 181.3 46.9 39.6 69.9 52.7 33.3 47.1 39.1 

98 177.7 45.4 40.7 73.8 54.7 36.4 49.7 41.9 

Notes: Column (1) shows total China exports (direct exports plus re-exports through Hong Kong) in billions 

of current U.S. dollars; column (2) shows Chinese re-exports through Hong Kong as a share of total Chinese 

exports; columns (3)–(5) shows the share of exports related to outward processing in direct Chinese exports to 

countries other than Hong Kong, Chinese exports to Hong, and total Chinese exports; and columns (6)–(8) 

show the share of exports by foreign-invested enterprises in direct Chinese exports, Chinese exports to Hong 

Kong, and total Chinese exports. 

Table 5: Direct Exports and Re-Exports of Chinese Goods for Selected 

Two-Digit Industries 

SITC T2Industry 

Industry 

Share 

of Direct 

Exports 

Industry 

Share 

of ReExports 

ReExport 

Share 

of 

Total 

Exports 

Outward Processing Share 

of 

FIE Share of 

Direct 

Exports 

Exports 

to 

Hong 

Kong 

Direct 

Exports 

Exports 

to 

Hong 

Kong 

(1) (2) (3) (4) (5) (6) (7) 

03 Fish 2.9 0.6 16.9 17.5 23.2 26.2 23.5 

05 Vegetables, Fruit 3.6 0.9 19.6 4.6 6.2 13.0 12.2 

33 Fuel Oils 8.2 0.1 0.8 5.7 28.8 0.6 4.8 

52 Inorganic Chemicals 2.1 0.3 12.2 5.3 7.0 4.2 9.2 

55 Textile Yarn Fabrics 10.2 8.7 48.6 26.5 37.8 9.1 27.1 

66 Nonmetal. Minerals 2.2 1.1 37.5 8.5 29.2 18.8 24.8 

67 Iron, Steel 2.7 0.2 8.6 43.1 55.5 4.4 13.1 

69 Metal Products 3.7 2.3 41.0 29.2 55.3 10.3 23.6 

75 Office Machines 0.6 3.4 88.1 81.3 97.5 63.0 56.2 

76 TVs, Radios 1.5 9.3 86.2 75.7 93.2 51.8 58.6 

77 Elec. Machinery 2.5 7.1 78.1 50.2 80.0 35.2 41.8 

83 Luggage 0.8 5.5 88.5 50.9 85.4 26.8 31.4 

84 Apparel 17.2 17.4 53.5 43.5 56.8 21.2 27.3 

81 

Table 5: Direct Exports and Re-Exports of Chinese Goods for Selected 

Two-Digit Industries—Continued 

SITC T2Industry 

Industry 

Share 

of Direct 

Exports 

Industry 

Share 

of ReExports 

ReExport 

Share 

of 

Total 

Exports 

Outward Processing Share 

of 

FIE Share of 

Direct 

Exports 

Exports 

to 

Hong 

Kong 

Direct 

Exports 

Exports 

to 

Hong 

Kong 

(1) (2) (3) (4) (5) (6) (7) 

85 Footwear 2.7 7.8 76.7 52.5 85.0 29.0 55.3 

88 Cameras, Watches 0.4 3.2 89.9 58.1 86.2 36.7 46.5 

89 Toys, Games 4.9 21.0 82.9 42.5 78.0 25.7 36.5 

Notes: The two-digit industries listed above are ones which account for at least 2% of direct Chinese exports 

or 2% of re-exports of Chinese goods through Hong Kong on average or the period 1988–1998. See notes to 

Table 3 for definitions of column headings. 

Table 6: Direct Exports and Re-Exports of Chinese Goods by Region 

Region 

Region 

Share of 

Direct Exports 

Region 

Share of 

Re-Exports 

Re-Export 

Share of 

Total Exports 

(1) (2) (3) 

Africa 3 .2 2 .6 49 .9 

East Asia 36 .8 18 .0 35 .6 

Eastern Europe 4 .2 0 .9 24 .8 

Latin America 2 .5 4 .2 65 .0 

Middle East 4 .0 2 .6 42 .8 

North America 16 .7 37 .3 71 .4 

Oceania 1 .7 2 .4 61 .2 

South Asia 2 .7 1 .0 30 .6 

Southeast Asia 11 .2 6 .0 37 .8 

Western Europe 16 .9 24 .9 62 .1 

Notes: This table shows each region’s share of Chinese direct exports in column (1) and of total re-exports of 

Chinese goods by Hong Kong in column (2). Column (3) shows the share of re-exports in Chinese exports to 

each region. All figures are averages over the period 1988–1998. 

Table 7: Hong Kong Markups on Chinese Processing Exports by SITC 

Industry, 1997–2001 

Outbound 

from 

China 

SITC 0—Food and live animals 20.9% 

SITC 1—Beverages and tobacco 63.3% 

SITC 2—Crude materials, inedible, except fuels 18.5% 

SITC 3—Mineral fuels, lubricants and related materials 4.7% 

SITC 4—Animal and vegetable oils, fats and waxes 21.5% 

SITC 5—Chemicals and related products 12.9% 

SITC 6—Manufactured goods 17.9% 

SITC 7—Machinery and Transport Equipment 28.5% 

SITC 8—Miscellaneous manufactured articles 29.6% 

SITC 9—Special commodities and transactions 14.1% 

Total 16.7% 

Notes: Hong Kong markups are computed as described in Feenstra et al (1999). 

82 


Insert illus hanson17.eps Insert illus hanson18.eps
83 

Panel II: Discussion, Questions and Answers 

Vice Chairman D’AMATO. Thank you very much for a very interesting statement, Dr. Hanson. And you had a paper you mentioned. 

We would like to see that. 

One announcement I want to make is that there’s been some interest and request for there to be an open mike. And we will have 

an open mike at the end of today’s afternoon session for those of 

you who would like to participate in that. So however long that 

goes, we don’t know, but we’ll make that available. I have one 

question before we go to other Commissioners for both—for the San 

Diego line here. I’m just wondering how formed up this line is. Because we talk about—you get the impression of—your description 

of a new business model and, you know, this production chain is 

sort of like this engine out there and whether we fit into it or 

whether we mold it—whether we mold it. 

There’s a lot of talk about trying to incorporate standards of different kinds, labor standards and environmental standards, into 

the—whatever model develops here. In fact, I think there’s going 

to be a 301 case submitted within the next two weeks on labor 

standards. 

The question is, how do you envision labor standards and environmental standards as becoming a viable part or not of this new 

business model? Have you thought of that—about that? 

Dr. FEINBERG. Yes. Very important question. Thank you very 

much. Currently U.S. policy is mandated by the trade promotion 

authority legislation, is that our negotiators are required, of course, 

to press for the inclusion of both environmental and labor standards in international trade agreements. That was done, in fact, in 

the case of the U.S.-Chile and the U.S.-Singapore Free Trade 

Agreement, which Congress passed. Those clauses are also included 


Insert illus hanson19.eps
84 

in the U.S.-Australia and U.S.-Central American Free Trade Agreements, which the administration has negotiated although not yet 

submitted to the U.S. Congress. In all of that legislation what is 

required is the countries implement their own national laws with 

regard to labor standards and environmental standards. And typically if you travel around the world, national standards are usually 

pretty good. In fact—on paper. 

In fact, if you travel around the world with regard to labor standards, as I’m sure Mr. Becker is very aware, many countries automatically incorporate into their national laws international labor 

organization conventions. Something the United States, in fact, has 

generally not done. 

So, in fact, in terms of national standards with regard to labor, 

very often other countries have superior standards, in fact, as compared to our national labor standards as written in law. The issue 

is implementation. That’s the issue, implementation. How does one 

assure that countries actually implement their own laws? And that 

is built now into our legislation. So I think the issue is how do we 

go about monitoring the implementation in these cases? And I 

would suggest that we ought to follow a multiple approach. 

One is trade capacity building, which is to say that in—very 

often the countries simply don’t have the capacity to implement 

their own laws. Their government bureaucracies don’t have the capacity. The managers, the workers, the workers’ leaders aren’t 

even aware of their own national laws in the area of labor and the 

environment. 

And we ought to structure, as part of our trade agreements, 

trade capacity building, which would put together resources which 

would assist in the implementation of national laws. The second 

point I would make, however, is that—some have argued that we 

ought to go to official sanctions-based approach, which is to say we 

should sign agreements which say if countries don’t live up to 

international standards, we’ll cut off trade. 

One killer problem with that approach is that countries simply 

will not sign those agreements. So we’re dead in the water if we 

start from the idea that there have to be tough, enforceable, hard 

sanctions with regard to labor in the environment. We won’t have 

any more trade agreements. 

What we can do, however, is look at the private sector. And in 

China, as well as in developing countries, most firms these days 

have what they call codes of conduct. And if you go into a factory 

in China that sells, for example, to Wal-Mart, you will find on the 

wall, often in Mandarin, their code of conduct. These are the 

codes—even if they don’t own the factory, if they just purchase 

from that factory, it’s just a contracting factory, there will be the 

code of conduct on the wall, Wal-Mart’s code, which is similar to 

all the codes basically that are pretty good—maybe not perfect, but 

pretty good with regard to labor standards. 

The issue is, are those labor standards really being implemented? And that’s where I think I would suggest that we look to 

the U.S. private sector to work together in a more organized way 

with the manufacturers, with the governments, with perhaps the 

international labor organization and the United States to work 

with the private sector to see to it that their own codes that everyVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00090 Fmt 6633 Sfmt 6602 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
85 

body accepts and they’re written into contracts, that their own 

codes with regard to labor and environmental standards are 

upheld. This, in other words, would be a voluntary market-baseddriven system which I think would be much more effective, much 

more powerful than some of the approaches we have been pursuing 

up-to-date. Thank you, sir. 

Vice Chairman D’AMATO. Dr. Hanson, did you have a point on 

that? 

Dr. HANSON. So in addition to formal institution building, I think 

it’s important to recognize that the informal practice of setting 

standards is influenced by the process of globalization itself. When 

multinational firms go abroad, they often export business practices 

that they follow at home. 

There’s a large body of research which shows that multinational 

firms tend to pay considerably higher wages, tend to employ more 

skilled workers and tend to be more rigorous about following local 

laws than domestic firms are, on average. And this is, in particular, true for multinational firms that are headquartered in the 

United States. So apart from—so one way in which we can help 

countries move towards greater enforcement of laws that are already on the books is by having multinational firms that are subject to much greater international scrutiny than are domestic firms 

based in a particular country. 

Vice Chairman D’AMATO. Thank you very much. Commissioner 

Becker. 

Commissioner BECKER. Thank you very much. In the interest of 

time, I’m just going to focus on one issue touched by both Dr. Haggard and Dr. Feinberg. This is on the Free Trade Agreements. And 

I’ll refer to your written testimony, Dr. Haggard, on page 6, referring to Free Trade Agreements telling us that in these negotiations 

the U.S. has argued for agreements that go beyond trade to include 

the full panoply of new issues that are of interest to American multinationals: services, investment protection, intellectual property 

rights, e-commerce and digital privacy. 

The U.S. has also sought to incorporate its domestic social agenda, particularly labor rights and environmental protection into 

FTA. I want to draw your attention to two different trade agreements. One, the Chilean agreement, in which we were told by Chilean authorities long before the agreement took place that they 

were willing to incorporate in the trade agreement with the United 

States the enforcement of their country’s laws, which, incidentally, 

were pretty good on labor rights. This was bitterly fought by multinationals in this country and rejected by the United States on their 

behalf. The second trade agreement I want to refer to is the Jordanian trade agreement in which we actually got a trade agreement before Bush became president. And in that trade agreement 

they agreed to enforce their labor laws, which were extensive and 

adjusted, in order to get the agreement. 

The Administration has repudiated this and said this is not the 

policy of the United States. I think it may even be in writing. So— 

but I’m not quite sure on that part. So the point I’m getting at, this 

is not the policy of the United States, and we may as well face 

that. It’s not the policy of multinationals. And the trade agreements reflect what the multinationals want. 

86 

And the last example I will give is we just concluded a Free 

Trade Agreement with Australia. One of the hot button issues in 

that trade agreement was eliminating the tariffs here in the United 

States on sugar. 

Surprise, surprise. The multinational lobby for sugar is one of 

the biggest in this country. And the agreement was finally concluded without adjusting the tariffs on sugar. So the multinationals 

got their way again. And this is what we have been fighting with 

Free Trade Agreements. 

Certain people in Congress have fought very hard to try to get 

some adjustment by the Administration, unsuccessfully. I just 

wanted to make a comment for your response. 

Dr. FEINBERG. Thank you. 

Well, very specifically with regard to the U.S.-Chile Free Trade 

Agreement. The U.S.-Chile Free Trade Agreements does require 

both parties, the U.S. and Chile, to enforce their national laws with 

regard to labor and the environment. It’s enforceable in the sense 

that if there is a finding through various panels that that is not 

the case, then the party would have to pay a fine, a monetary fine. 

In the event—that is to say, there would not be a trade sanction, 

but there would be a monetary fine. 

If the party did not agree to pay that monetary fine, then the 

other party, the offended party would have the right to impose a 

trade sanction at that point. 

The emphasis is on enforcement of national laws. As you suggested in the case of Chile, the national laws were already pretty 

good; in fact, one could argue better even than in the United 

States. 

With regard to environmental laws, actually, in order to—during 

the course of the negotiations the Chileans thoroughly revised their 

national laws with regard to the environment and considerably upgraded them. So I would say that was an advantage of negotiating 

a Free Trade Agreement. 

What is missing—and I think perhaps this is what the Commissioner is referring to. In the U.S.-Chile agreement, and similarly 

with the other agreements that we’ve just been negotiating, country—the parties, the countries agree to—where national standards 

are below international standards, the countries simply pledged to 

seek to raise their national standards to international. Simply seek 

to. 

That is to say, they are not obliged to. And in the event that they 

do not, that they do not, in fact, seek to, they do not strive to, then 

there are no sanctions in that case. And I think that has—that has, 

I think, correctly been criticized. That’s rather weak language. I 

would just—one very quick point with regard to the sugar issue. Of 

course, the U.S. private sector, as we were discussing during the 

break, was very divided on this issue. The agricultural producers, 

some of them, of course, want to keep their protectionism, naturally. Some of the users of sugar, you know, the confection industry, for example, candy industry, you know, was disappointed. They 

would like to see more imports. I think this—of sugar and cheaper 

sugar. 

This goes to, I think, one of the bigger issues we have in the 

United States, which is we no longer have a consensus on trade 

87 

policy. The country is deeply, deeply divided and we’re in a situation in which it’s very hard to put together a consensus and nobody 

wants to yield an inch. And every company, every trade association 

is in there just fighting tooth and nail. And we have a problem. In 

political science we’d say there’s a problem of aggregation of interest. And it seems that the political parties and the U.S. Congress 

are not capable at this point of sort of aggregating these interests 

in the way that reflects a broad national interest. And I think this 

is a major problem facing the United States today. 

Vice Chairman D’AMATO. Thank you very much. Commissioner 

Reinsch. 

Commissioner REINSCH. Well, I just can’t resist wading for 30 

seconds into sugar and just observe for my colleague, Commissioner Becker, there were plenty of multinational companies that 

were very unhappy with the outcome of the Australian agreement. 

The real multinational companies are in the confectionery business and in the sugar-consuming business, and they worked very 

hard to get an expansion of the quota and were very disappointed 

when they didn’t. This was not a case of the multinationals all 

being on one side. My questions, however, are for Dr. Hanson, and 

I think there’s only two, although that depends a little on what you 

say. You mentioned in the beginning as the economy evolves, the 

United States, as it has historically done, would move into new sectors and new product categories or areas to make up for the jobs 

that we were losing elsewhere. Can you give me some examples of 

what those new areas might be. 

Dr. HANSON. We can look. Just within manufacturing, if you look 

where job growth was most active in the 1990s, it was in technology-intensive sectors. It was in electronics, it was in semiconductors and, also, in business services that were helping those 

firms export their goods and services. 

Commissioner REINSCH. Well, that’s services—okay. But let’s be 

a little more recent than the ’90s because a lot has changed since 

then. 

The last three years, has there been a lot of job growth in the 

sectors you just mentioned, or is that where we should be looking 

for the future? 

Dr. HANSON. No, I don’t think so. We’re in the midst of a shallow, but prolonged recession and a slow recovery. I think it would 

be a mistake to forecast from the trough of a business cycle what 

the next ten years are going to look like. Just like it would have 

been a mistake in 1990 to say that sluggish employment growth 

was going to characterize what we were going to see in the coming 

next ten years. The U.S. economy continues to surprise. And perhaps the most surprising thing about the 1990s was the return of 

productivity growth. That in the end is what makes us all better 

off. And in the absence of the capacity to generate productivity 

growth, standards of living in this country will stagnate. 

Commissioner REINSCH. Fundamentally, I agree with a lot of 

what you’re saying. I think the essence of the political debate in 

Washington is concern that what has been an historic evolution 

may have come to the end of the line. And that the politicians, at 

least, maybe not the economists, are having difficulty seeing where 

the next groups of jobs are going to come in the economy. 

88 

And I think that one of the things that’s going to have to happen 

is that we’re going to have to come up with better answers to that 

question, rather than simply saying that it’s going to happen because that’s what’s happened before. 

Maybe that’s true, but I think—where is it going to happen, how 

is it going to happen are legitimate questions. 

Let me ask you another question, if I may, in the remaining time 

out of complete and total ignorance, which I confess, which is what 

does investment—what does high levels of investment in human 

capital mean in practical terms? 

Dr. HANSON. What that means, very simply, is raising average 

education levels, producing more college graduates and producing 

more college graduates. 

Commissioner REINSCH. Okay. So what do we do? You’re talking 

about education programs primarily? Training? 

Dr. HANSON. Yes. I don’t want to go on the record in terms of 

making specific recommendations for types of education programs. 

I merely want to draw attention to countries that have made successful transitions out of head-to-head competition with low-wage 

economies. The countries that have done so are countries that have 

seen rapid increases in the share of college graduates, in the share 

of engineers and other highly technically trained workers in the 

labor force. 

Commissioner REINSCH. Now, that was a very useful example, 

and I want to study it. I asked the question because I give this 

speech all the time. In fact, I gave it last night here in San Diego. 

And I made the same comment about how we need to do more of 

this stuff. The problem for people in our business, which is not education, is to try to translate that into both dollars and cents and 

specific programs. That’s what we want to do. We want to increase 

the level of education. How you do that seems to be a mystery. I 

think the country has something of a record of failure over the last 

decade in that regard. 

Dr. HANSON. Let me make one point, which I think is often not 

fully appreciated. And that is, when—recognizing that the adjustment costs involved in dealing with expansions in trade and the 

spread of new technology have been large and important and impacted many parts of this country. When you slow down that adjustment process, you lower the incentives to make those investments in human capital. You hinder the ability of those new dynamic sectors, whatever they may be, to grow and develop. 

That is, there are consequences from keeping workers locked in 

the textile sector. And that those consequences are other sectors 

that are more dynamic that have greater potential for productivity 

growth can’t expand as quickly. 

Commissioner REINSCH. Well, so you would support Dean 

Cowhey’s suggestion that we give them all an annuity? 

Dr. HANSON. Million dollars each? 

Commissioner REINSCH. Not to put you on the spot or anything. 

Dr. HANSON. No. But to come back to this issue of trade adjustment assistance, and here is where, you know, the typical line of 

economists is to say, look, they’re gaining some trade, let’s lower 

trade barriers and reap the gains from trade and let’s not worry 

about where the costs get allocated. 

89 

I think a politically more realistic line has got to say, for those 

individuals who are going to bear the brunt of the adjustment 

costs, what can you offer them to make that transition easier? 

There’s been a fair amount of debate over the last ten years 

about whether the best way to do that is a very directed intervention in terms of retraining, or intervention that’s much less directed and that involves mainly income transfers. 

The research is—is—the jury is still out, but there’s—a lot of the 

research is skeptical about the ability of government entities to 

judge where those retraining activities should be concentrated and 

that we might be better off with something that’s not too different 

from an annuity; basically, income support for individuals who are 

stuck bearing the costs of these changes. 

Commissioner REINSCH. Thank you. 

Vice Chairman D’AMATO. Thank you very much. Commissioner 

Wortzel. 

Commissioner WORTZEL. Thank you. I want to focus on this same 

area, Dr. Hanson. It’s an interesting one. And I really appreciate 

that your entire set of arguments has been really grounded in substantiating data, which we don’t always hear when we hear these 

arguments on the macroeconomic level. 

And although it’s somewhat out of role for me to this type of 

question, I’m going to ask it because at one of the hearings that 

we had a group of union representatives and also, to get into political economy, the elected representatives, the congressmen from 

certain congressional districts. 

And we listened to a very impassioned speech about constituents 

who essentially said, I grew up in rural Pennsylvania or in High 

Point, North Carolina. My parents grew up there. My grandparents 

grew up there. I want to raise my kids there. I don’t want them 

to have to move off to some other place. 

And I guess the answer I hear from you is: tough. Your kids are 

going to have to move, and you’re probably going to have to get reeducated and move. 

Now, that, from a macroeconomic standpoint, works great. From 

the standpoint of political economy in a congressional district, it 

doesn’t sound like a real good solution, especially if you’re trying 

to get reelected. So how would you respond to that congressman? 

Dr. HANSON. So—— 

Vice Chairman D’AMATO. Are you running for reelection? 

Dr. HANSON. Fortunately, not. I think we can forecast the success of my political career. We can find lots of examples of communities that have taken a very hard hit from greater exposure to 

trade. But not just greater exposure to trade; also, the fact that 

technology has left certain industries behind. Newsprint, because of 

changes in technology, is a production process that now involves 

virtually no labor. There are many communities that have been affected by that development, completely apart from trade. I think 

we can find examples, though, of communities that have made that 

transition and that didn’t involve the children and the grandchildren having to leave. Pittsburgh is one example. It’s hard to 

think of more of a—a better—a city that more exemplified the rust 

belt of U.S. manufacturing than Pittsburgh, which has found sort 

of new life in software, in electronics and other parts of high tech. 

90 

Now, did that happen because of directed government programs 

which said this is going to be Pittsburgh’s future? No. It was an 

organic outcome that reflected the skill base that Pittsburgh had. 

It’s got a concentration of excellent universities and individuals 

who saw opportunity, pretty skilled workers in an area where property prices were low and that was pretty depressed. 

So that’s—that’s one example to say we can’t tell you what the 

future is going to be, but what’s the alternative? The alternative 

is constructing barriers that essentially keep workers in industries 

that are going to face competition from lower and lower and lower 

wage economies. 

And it’s hard to see what the exit strategy from there is going 

to be except higher adjustment costs at some later point in the future. 

Commissioner WORTZEL. Well, I don’t know if you’ve written that 

paper, but I would suggest to you that a paper with those examples 

is going to have a great sort of intellectual market around this 

country. 

Vice Chairman D’AMATO. Thank you very much. Commissioner 

Dreyer. 

Commissioner DREYER. Yes. To some extent my question has already been asked by Commissioner Reinsch, but let me elaborate 

on it. I am getting the impression that a simple translation of the 

San Diego party is, don’t worry, be happy. And since particularly 

Dr. Hanson and Dr. Feinberg seem to be congenital optimists, I 

will confess at the outset that I am basically a pessimist. 

I am wondering when you say workers do find other jobs, even 

though it may take a while, what percentage of these workers are 

you talking about and what kinds of other jobs are they finding? 

I would add to that, while I totally agree with you that we need 

to educate our youth out of this situation—in other words, we need 

to educate them better to compete technologically—I don’t see it 

happening. And since I don’t have my university’s administrators 

sitting here to listen to me the way you do, I’m going to go out on 

a limb on this one and say probably in most places in the country 

it isn’t happening. 

We are not, by and large, educating our students to be more 

technologically ept. We are educating them in diversity. We are 

educating them on participating in campus sports. We are educating them in all kinds of things, but we are not pushing them 

toward math and science. Everyone talks about the need for diversity on the teaching staff. We have some departments at some universities that have no diversity at all. What is lacking is Americans, because there are so few Americans that have the necessary 

qualifications. 

They departments are totally Indian and Chinese. And once this 

preponderance of non-American faculty members gets to a certain 

stage, you find your young Americans who are not Indian or Chinese being afraid of going into the department because they think 

they don’t fit. What’s happening? We have a math phobia among 

our high school graduates. And if you mention physics to many students, they cringe. And if that’s not happening at your university, 

you should know it’s happening in most other areas. 

91 

Dr. HANSON. I’m not exactly sure which—where the question was 

in there, other than just an—— 

Commissioner DREYER. Let me be very explicit in case you 

missed it. One, where are these people being retrained, and what 

percentages of them are being retrained? And, two, have you not 

noticed here that we don’t seem to be very good at drawing young 

American students into the fields that you say we need to be better 

educated in? 

Dr. HANSON. I had focused on the second part of your question 

and forgotten the first. On the issue of how or where workers get 

reemployed, let me refer you to a work by Lori Kletzer, who is an 

economist at the University— 

Commissioner DREYER. Say it again. 

Dr. HANSON. Lori Kletzer. 

Commissioner DREYER. K? 

Dr. HANSON. I can provide the cite to the Commission. 

She’s an economist at the University of California, Santa Cruz, 

who has looked at the issue of job displacement associated with 

trade. To generally sum up her findings, workers who are in industries that get hit by increased imports tend to suffer wage declines 

as they’re pushed out of jobs in one sector into another sector. 

The majority of them end up getting reemployed somewhere in 

manufacturing, but a substantial fraction leave manufacturing and 

work in services. 

So the costs are real. And this is not to say—nothing in my remarks or I think in anybody—anyone else’s remarks here is to suggest that these adjustments are cost-free. On the contrary, one of 

the basic tenets of international economics is that when you have 

greater integration between countries, there are going to be sectors 

that expand in benefit and there are going to be sectors that contract and that take a big hit. 

The question is, how do you want to incorporate that transition? 

Do you want to put it off to a very distant date in the future? Or 

do you want to deal with these issues as they come up? Or do you 

want to recraft the way the United States fits into the world economy? Do we want to get actively involved in really insulating the 

United States from competition? Personally, I find that a scary 

prospect. 

On the issue of math phobia, I can assure you that personally I 

do everything I can to encourage enthusiasm about mathematics, 

though I think with limited success. 

Commissioner DREYER. And by the time they get to college, it 

may be too late. 

Dr. HANSON. But I think—you talk about Americans in particular. The U.S. higher education has become an important export 

industry. We draw workers from all over the world to come to what 

is the finest collection of universities that one can find anywhere. 

I’m bragging slightly. But it’s—I think it’s important to recognize 

when we draw those individuals here, we keep some of them for 

a while. Sometimes for their entire lives. And they become important innovators in industries that are at the cutting edge of technological development. If you look at the development of Silicon Valley in the 1990s, who were some of the key entrepreneurs? They 

were engineers from China, engineers from India. 

92 

So if you ask me, does it matter whether it’s Americans or people 

who’ve come in from abroad to help lead the U.S. economy into a 

new future? I don’t know that I’m as concerned as long as that innovation is happening, that productivity growth is happening and 

those benefits are then being felt throughout the economy. 

Commissioner DREYER. Thank you. 

Vice Chairman D’AMATO. Dr. Feinberg, you had a comment. 

Dr. FEINBERG. Yes. Thank you. Well, I appreciate being considered an optimist. I consider myself to be an optimist, yes, but a realistic optimist. So let me see if I can make a couple of relevant 

comments and also very much keeping in mind that your Commission’s job is to look at the national security impact of U.S.-China 

economic relations in particular. In that light—first, simply with 

regard to the issue of adjustment assistance, of course, we have 

been debating this in the United States for a long, long time now. 

We have any number of programs for adjustment assistance in the 

United States, run for the most part by the Department of Labor 

and the Department of Commerce. The problem is these programs 

are terribly under funded, and there simply has—way, way under 

funded. And so, therefore, they don’t have credibility. This is the 

big problem you have politically. 

The unions and others, when they hear people talk about trade 

adjustment assistance, they say, yes, we have been hearing this for 

20 years, and where’s the beef? 

So I think if the Congress and others are going to get serious 

about trade adjustment assistance in whatever form it may take, 

it has to be a serious budget item. And so far the Congress has not 

been willing to look at it in those terms. In terms of the job threat, 

however, it’s been mentioned here in the previous panel, but I want 

to underscore. If we think there’s a threat from China in terms of 

low-wage jobs, it’s a much greater threat in the rest of the developing world. 

For example, when the tariff—when the textile and apparel 

quotas are released at the end of this year, if, in fact, they are released, just in Central America alone there are 400,000 jobs dependent upon that sector. It was mentioned that the United States 

stands to lose 400,000 jobs in the sector. The United States has a 

labor pool eight to ten times the size of Central America. In other 

words, the impact of the potential loss of 400,000 jobs in Central 

America is eight to ten times the impact that such a loss in that 

sector would have in the United States. It could be devastating for 

the young democracies in Central America if all of those jobs simply pick up and go to China or other low-wage Asian countries. 

And that’s an area where we know from history, there’s a direct 

national security interest on the part of the United States. So I do 

think we have to look very carefully. And, frankly, I don’t agree 

that it’s simply enough to say, well, free trade, you know, benefits 

everyone in the long run. There’s an issue of speed of adjustment. 

Speed of adjustment. 

And whether or not the developing world—where we have important economic and security interests, whether the developing world 

can withstand the onslaught of low-wage trade particularly out of 

China in the short term is something I think we do have to look 

at very closely. 

93 

So it’s a national security foreign policy issue as much as it is 

a domestic economic issue. If I could just make two other points 

with regard to the national security issues and budgets. 

It was mentioned in the last panel that the budget deficit is the 

primary driver, after all, of our overall trade deficit, which, in turn, 

is allowing particularly Japan and China to run up very, very large 

and rapid accumulations of U.S. reserve assets. That is to say, the 

U.S. dollar. That may be perfectly benign, and there may be a perfect and simple market adjustment. The dollar falls, perhaps U.S. 

interest rates may have to rise a bit. It may all settle out. But it 

may not, particularly if the budget deficits continue to balloon as 

all projections now suggest that they, in fact, will. 

I, for one, wouldn’t want to be running our national security policy with the thought that our leverage over China is significantly 

being reduced as they accumulate massive amounts of dollars. And 

although they probably wouldn’t—just like, you know, people accumulate arms and they probably will never be used. Nevertheless, 

they have at least a psychological impact if China is sitting on 200 

billion and rapidly rising reserve accumulation of U.S. dollars. So 

I think this is something for us to think about—the budget deficit, 

in other words—as a national security issue beyond simply the economics of jobs. 

We have—we do not have in place—with Europe, for example, we 

have in place all sorts of mechanisms to deal with exchange rates 

and accumulation and banking systems. We’ve just begun to put 

those in place, for example, with the Chinese. 

So I think we have to really look very carefully at this whole financial issue and dollar issue as very much part of our national security. And when you run large, continuing, booming budget deficits, we have to see the downside of that in terms of our national 

security. The final point, and just to maintain my reputation as an 

optimist, the price of many U.S. products—of many imports that 

we are importing into the United States has been falling and falling dramatically in the last 10 to 20 years. And a lot of this isn’t 

really picked up in the consumer price index because the quality 

is improving or these products didn’t even exist before, but they, 

nevertheless, improve our quality of life. 

Clothing and apparel in stores today are cheaper than they were 

ten years ago, for example, not to mention the boom in electronics. 

That means that the real standard of living of Americans, including American workers—at least those that are employed or even if 

you just have a Social Security check. The real value of your—each 

dollar in terms of its purchasing power, in fact, is increasing. 

And we do need to recognize that while we tend to focus on individuals as workers, individuals are also consumers. And this tremendous boom in trade from low-wage areas, although it certainly 

is a cost to some Americans as workers, is also a tremendous benefit to all Americans as consumers of these lower cost imported 

products. 

Vice Chairman D’AMATO. Thank you very much. Commissioner 

Bartholomew. 

Commissioner BARTHOLOMEW. Thank you very much. 

Thank you to our witnesses. Generally I try to ask questions because I believe the purpose of these hearings is for us to get at the 

94 

benefit of your expertise, rather than share any that we might 

have. But I’m going to break my own rule and offer just three comments. One is that, since Commissioner Reinsch and I disagree 

more often than we agree, I wanted to agree with him on the concern as it’s playing out in Washington, and just because something 

has happened in the past in a certain way, doesn’t mean that it’s 

going to unfold in the future the way it has. 

And I think that some of the concern is that there certainly 

seems to be a speeding up of the process as globalization moves forward and escalation of job loss, and that is one of the points that 

is of real concern. The second one is it really strikes me, as we’ve 

heard all morning and I suspect it will move forward into the afternoon, that a lot of you really are talking about trade in an ideal 

world. It’s a world of free trade that exists free of trade-distorting 

activities such as dumping, bogus phytosanitary standards, intellectual property rights. And when you factor those in, the issues 

become a whole lot more complicated. And, frankly, we have to factor them in. And third, Dr. Feinberg, specifically you mentioned 

two options. As I’m sure you know, there’s a lot of skepticism about 

the effectiveness of these codes of conduct. It’s been an issue that’s 

been going on a long time. But I would like to put a third option 

on the table—what can help improve worker standards? And that 

goes, again, to a basic issue of freedom, and the right for people 

to organize independent labor unions. I believe that those would 

make an enormous difference in the ability of people to change 

their working conditions and make it a more competitive field for 

American workers. 

That’s it. Thanks. 

Vice Chairman D’AMATO. Thank you very much. One more question, Commissioner Mulloy. 

Commissioner MULLOY. Dr. Hanson, I’m sorry I didn’t have your 

prepared testimony before the hearing. So I’m going to base my 

questions to you based on your oral testimony. 

You noted that I quoted Mr. Mankiw, who is the chairman of the 

President’s Council of Economic Advisors, and then discussed about 

outsourcing and about that being good for the American economy 

even though it’s going to result in millions of jobs lost. According 

to the Forester prediction, we’re going to lose 3 million white-collar 

jobs over the next ten years on outsourcing. Now, Paul Craig Roberts, who was an assistant secretary of the treasury under President Ronald Reagan, a Republican, and Senator Schumer, a Democrat from New York, have said that the theory of comparative advantage under Ricardo, which is the basis of all of the theory of 

free trade, is no longer applicable, and trade has now become a 

zero sum game because of the integration with these other economies. I don’t know whether that’s true or whether it isn’t true, and 

so I’m looking for advice. But we did have a witness at our South 

Carolina hearing, not a laborer, but a CEO of a corporation who 

told us too often free trade has become an ideology among the 

American class of economists, rather than a strategy of what serves 

the national interest. So let me just follow up with that. You said 

that laborers get reemployed, that if a guy loses his job here, he’s 

going to get reemployed somewhere else. The question is, does he 

get reemployed at a lower standard of living, a lower income for 

95 

him and his family? And if so, what are the implications of that 

for the American tax base on which, you know, we preserve our 

standard of living? 

Dr. HANSON. Let me take your second question first. Again, citing the work by Professor Lori Kletzer at UC, Santa Cruz, the job 

loss associated with increased import competition, you find that on 

average workers suffer about a 15 percent hit in their wages when 

they’re pushed out of one job into another. Now—— 

Commissioner MULLOY. So they get a lower wage in the new job. 

Dr. HANSON. They get a lower wage in their new activity. 

Commissioner MULLOY. And the tax base, then, is affected by 

that? 

Dr. Hanson. Well, before we get to that point, I think it’s important to recognize that that 15 percent hit is the same whether you 

lose your job because of increased competition from imports or increased competition from a competitor who is in a different state 

or because of other changes in the economy that adversely affect 

your firm. 

There’s nothing special about imports. When workers are forced 

out of work in a particular line of business, they tend to suffer a 

hit in terms of their income. 

Now, in terms of thinking about the implications for the tax 

base, you’ve got to take into account that those opportunities for 

trade are creating higher incomes and job growth in other parts of 

the economy. Let me cite one example that’s not related to China, 

but it’s related to NAFTA. As we saw trade between Mexico and 

the United States increase in the 1990s and we saw increased 

outsourcing from the U.S. to Mexico, what did we see on the U.S. 

side of the border? An increase in manufacturing jobs of firms that 

produced parts and components that their Mexican counterparts 

then assemble into final goods and ship back to the United States. 

That’s an example of the sort of employment growth and wage 

growth that free trade brings about. If you want to think about the 

aggregate effect on the tax base, you got to sum up not just the 

guys who are losing their jobs and suffering wage hits, but also all 

those workers who are finding jobs at higher wages than they had 

before. 

Commissioner MULLOY. Do either of you want to offer any comment? 

Dr. HAGGARD. Yes. I want to go on the record with respect to the 

‘‘don’t worry, be happy’’ approach which has been characterized as 

the San Diego line, which I really don’t share at all. 

Vice Chairman D’AMATO. Is that the San Diego line? 

Dr. HAGGARD. I would like to clarify my position with respect to 

the effect of trade and trade agreements on employment. We all 

agree that deeper integration has distributive effects. I think that’s 

an axiomatic part of economics. 

I think the concern is that trade policy is not the appropriate instrument for solving those problems. Even if trade is adding to adjustment difficulties that are caused by other factors that doesn’t 

imply that by employing protectionist instruments that workers 

will, in fact, be beneficiaries. 

And I’m not talking here about efficiency arguments. I’m not 

talking about job creation arguments. I’m just asking the question 

96 

whether, if we protect, do workers, in fact, pocket the gains from 

that protection? And I think we have a history of suggesting the 

opposite. Take, for example, the steel industry. The steel industry 

secured substantial protection during the ’70s and ’80s. What happened? The industry still lost roughly half of its work force during 

a period when you had substantial bilateral restraints imposed 

across a range of countries. 

So my concern is not just with efficiency arguments: that there 

are overall welfare looses from protection. I am concerned that in 

the absence of a broader social policy, the union movement, the 

labor movement in the United States reaches for protection as a 

device for solving these other issues, but, in fact, it doesn’t end up 

protecting employment. 

We’ve seen this pattern repeatedly. It’s happened in textiles, as 

well. Textiles have shrunk even in the face of the maintenance of 

the multifiber agreement. So I think that Dean Cowhey’s comments 

were really important for the Commission’s work and for U.S. policy as a whole. We can’t look at the jobs question solely or primarily as just a trade issue. We have to reinvigorate the broader 

discussion of social policy in the United States to accompany the 

course of globalization. 

Now, unfortunately—and this is my last comment on this—I 

don’t think that the national level is necessarily the level of government that is most appropriate to handle some of these adjustment 

processes. 

And what we see in San Diego or in Pittsburgh is that local institutions, partnerships between universities and firms, the local private sector working with local governments, may play a much more 

important role in making this adjustment more effective than anything that comes out of Washington. 

That isn’t a good message to carry to policymakers on the Hill 

or in the White House, but that may, nonetheless, be the case. 

Commissioner DREYER. Thank you. This is very helpful. 

Vice Chairman D’AMATO. Dr. Feinberg. 

Dr. FEINBERG. Just as a reality take, I would point out that currently U.S. trade policy is stalled, very stalled. The WTO negotiations, the ministerial negotiations are dead. The effort to move 

ahead with the Free Trade Area of the Americas is badly stalled. 

The most recent negotiations last week broke down. And it’s very 

questionable as to whether or not any of these smaller FTAs can 

now get through the Congress. The betting is that the administration will not try to put any before the Congress this year. 

So we actually already have a deadlock in U.S. trade policy. I 

think that’s important to have that as a starting point. Very often 

there’s a view that, oh, we’re moving ahead rapidly towards a more 

liberal, open trading regime. That’s not the case. Trade policy is 

currently very stalled. I did want to respond, if I could briefly, to 

Commissioner Bartholomew’s comment about codes of conduct, if 

you would. I agree that codes of conduct can be weak or strong, depending upon the code of conduct, and we should all strive for a 

high code of conduct that accords with ILO standards, and that, of 

course, would include the right of association and the right to form 

unions if that’s what the workers—freedom of association and the 

right to form unions, which is what workers would want. For a 

97 

code of conduct system to work well, the workers, the managers, 

the supervisors all have to be educated in that code, which is not 

always the case. There have to be good, high-quality audits by external third parties who are objective and are doing a good job. 

And then you have to have means for a corrective action. When 

there are problems cited, how are they going to be taken care of? 

I would suggest that if you have that sort of system and if it’s comprehensive across a country or a region, that that does hold the 

promise for raising labor standards in developing countries if it’s 

done properly. Thank you. 

Vice Chairman D’AMATO. Thank you very much. I think this is 

a good way to conclude our morning session. I’m going to thank the 

panelists for your contribution, and we’ll be getting transcripts of 

our session around to you for your editing. 

Commissioner MULLOY. Commissioner D’Amato, can I just follow 

up one second. Dr. Haggard, I think you were absolutely right. I 

don’t think trade policy is the total vehicle to deal with these problems. And I would hope the San Diego group under Dean Cowhey 

could help us maybe give some ideas on what is the appropriate— 

what are the elements of a strategy to help us deal with these 

problems that we have been discussing this morning. 

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

much, Commissioner. That will conclude the morning session. And 

we will resume at 1:15. Panelists and invited guests are invited to 

lunch now. And I would also remind you that those that have 

asked for an open mike, we will have an open mike at the conclusion of the afternoon session. Thank you very much. 

(Noon recess taken from 12:27 p.m. to 1:27 p.m.) 

AFTERNOON SESSION, THURSDAY, FEBRUARY 12, 2004 

OPENING REMARKS OF CHAIRMAN ROGER W. ROBINSON, JR. 

Chairman ROBINSON. If we could please take our seats, we’d like 

to begin the afternoon session. 

I would like to open the afternoon session, which is going to be 

most interesting after a very, very stimulating morning. We apologize for getting started a bit late, but I would like to turn over the 

proceedings for the afternoon session of this field investigation to 

our cochairman for today, Ambassador Robert Ellsworth. 

PANEL III: BIOTECHNOLOGY PANEL 

Co-Chair ELLSWORTH. Thank you, Mr. Chairman. 

And thank you, Mr. Vice Chairman, for your leadership this 

morning. 

So now we have a panel on biotechnology, and our panelists are 

Dr. Lee Zhong, M.D. and Ph.D., who is president of Elene Pharmaceutical Company; Dr. Kerry Dance, Ph.D., who is the managing 

partner at Hamilton Apex Technology Ventures, LP; and in the interest of full disclosure, I also am a partner in that firm. 

Joe Panetta is the president and CEO of BIOCOM, which is the 

local San Diego biotechnology industry organization, if you will. 

And we have also on our distinguished panel Greg Lucier, who is 

the president and CEO of Invitrogen Corporation. And if I’m not 

mistaken, that is the biotechnology company in San Diego that has 

98 

the highest revenue—more revenue than any other biotechnology 

company in San Diego County. And his company is located in 

Carlsbad. So, gentlemen, thank you for coming. The procedure is— 

if you were here this morning you already know it, but I’ll repeat 

it anyway. I call on each of the panelists in order, and each of you 

gives us a statement of seven or eight minutes’ duration—no more 

than that, please. 

And then we have a round of questions and answers between you 

and the Commissioners up here at the table. And each Q and A period is limited, please, to five minutes. And that includes both the 

Q and the A. 

So, Dr. Zhong, may we invite you to lead off this afternoon, 

please. 

STATEMENT OF LEE ZHONG, M.D., Ph.D. 

PRESIDENT, ELENE PHARMACEUTICAL CO. 

Dr. ZHONG. Thank you, Mr. Chairman and Mr. Co-chairs, and 

the vice chairman and members on the Commissions. 

It’s a great honor to be invited here today to talk about the 

China pharmaceutical industry and the China pharmaceutical markets, which is becoming more and more important in the world’s 

pharmaceutical markets and industry. Now, China’s pharmaceutical market during the past 25 years is one of the fastest growing world markets. And there was an annual growth rate of 17 percent. 

In the year 2000 China’s pharmaceutical market has a market 

size of 6.8 billion U.S. dollars, and it ranks as the seventh largest 

in the world. According to Table 1 on page 1 and—China’s pharmaceutical market is going to become the fifth largest in the world by 

the year 2010. Now, the driving force for this market growth includes rapidly expanding national GDP, rising Asian population, 

increased access of general public to the healthcare products and 

the low per capita health expenditure. As we can see here on Figure 1 on page 2, China currently spends $15 per person every year 

on healthcare products. This figure is much lower than the $300 

per person that the U.S. spends, and it involves a much lower than 

the $50 figure spent by the second high development countries. So 

this leaves a huge load for future upward growth. China pharmaceutical industry consists of 6,000 companies. And it is obviously 

very fragmented because the top ten companies only represent less 

than 10 percent of the market shares while in the United States 

top ten companies have more than 60 percent of the market shares. 

And the domestic Chinese companies consist of about 65 to 75 

percent of the market share, and the following companies consist 

of 25 to 35 of the market share. 

The industry is divided into three sectors, and the largest is the 

chemical drug sectors, which is—have about 65 to 70 percent of the 

market share. And the traditional Chinese medicine sector, which 

is TCM, takes about 20 to 25 percent of the market share. And the 

biotech is the smallest, which has about less than 10 percent of the 

market share. The chemical drug sector of the Chinese pharmaceutical industry has about 3600 companies, but half of them will 

be closed after year 2004 because of facing the fierce competition 

99 

from foreign drug companies and also because of not being able 

to—to meet the requirements of being GMP-compliant. 

China is the second-largest active pharmaceutical ingredient 

manufacturer and supplier in the world. However, the products 

that Chinese pharmaceutical companies manufactures are mostly 

generic or copy the drugs; very, very few are innovative drugs. 

Therefore, the Chinese pharmaceutical industry needs to invest 

in R&D to develop its own novel products. And it also means more 

management to increase efficiency and also needs to implement 

GMP system to enhance quality control. The second sector of the 

China pharmaceutical industry is the traditional Chinese medicine 

sector. It consists of about 1800 companies. 

Since TCM has a long usage—long history of usage in China, it 

is accepted by many Chinese. And it is indeed effective in many 

chronic diseases with relatively fewer side effects. And it is also a 

niche market to many Chinese companies because it is without any 

competition from foreign companies. 

However, the modernization of the TCM companies is also inevitable, which usually involves with product standardization and 

their GMP implementation. 

The third sector is the biotech sector. Since Mr. Greg Lucier is 

going to talk extensively about this sector, sir, I’m going to skip 

that sector for now. 

The foreign investment in China’s pharmaceutical industry contributed greatly in the growth of the industry by bringing in capitol, management systems and technologies. By the end of year 

2002, there’s more than 1500 joint ventures established between 

Chinese companies and the foreign companies. The total foreign investments reached 3.6 billion U.S. dollars. And in year 2002 alone, 

the foreign investment is about 1.2 billion U.S. dollars. Until now 

about 19 of the top 20 largest multinational pharmaceutical companies have established a presence in China. And the foreign companies account for about one-third of the chemical and biotech drugs 

sold in China. Initially when they first started to do business in 

China, most of the foreign companies put focus on established manufacturer capacities by established manufacturer facilities. Now, 

these days it seems they also are start into establish R&D centers, 

as well. 

And they’re doing this to try to make use of the low cost of doing 

research in China. For example, in the United States—a research 

scientist in the U.S. research laboratory would cost about $200,000 

a year to do research. But an equivalent scientist in China will 

only cost about 50,000 U.S. dollars. The U.S. is the second-largest 

investor in the China pharmaceutical industry just after Hong 

Kong. And U.S. has shifted most of its APR production, about more 

than 70 percent, to overseas and a good portion to China. And the 

U.S. has also shipped a substantial portion of the generic finishdose formula production overseas, but not to China yet; but I think 

within ten years it will go to China, as well. 

The U.S. companies also have started R&D activity in China, 

but, in our opinion, it will be quite limited. 

Before 1993 there was no intellectual property rights protection 

in drug products; but since then, IPR protection has improved significantly, especially after the WTO entry. 

100 

China has promulgated many laws designed to guarantee IPR 

protection and repealed about 2,300 laws incompatible with WTO 

requirements. China also applied a judicial enforcement, as well as 

an administrative enforcement. However, intellectual property in 

many areas is still a problem, especially in the enforcement aspects. 

So in summary, China’s pharmaceutical industry is evolving not 

only to be a dominant manufacturer powerhouse, but also to become a competitor in R&D. 

Foreign investment and the transfer of technologies and management systems contribute greatly in the development of China’s 

pharmaceutical industry. And the investment and joint venture’s 

are mutual benefits. The foreign companies take over substantial 

Chinese markets and enjoy low cost while China gets capitals and 

technologies to modernize its industry. 

There are several favorable factors for foreign investment, which 

includes government support, economic growth, low labor cost and 

the larger pool of talented scientists. And also, most recently, 

there’s improved IPR protection. However, there are also some constraining factors for foreign investments. IPR is always an issue, 

especially in the implementation aspect. And there are certain administrative policies, such as strict price control of drug, which 

would cut the profit margin of the drug companies. 

And, also, there’s inefficient drug distribution channel in China, 

although recently it is improving. 

And, lastly, there’s multiple regulatory bodies in the pharmaceutical industry in China. So this possibly will make doing business in China little bit more difficult. Okay. Thanks. Just end 

there. 

[The statement follows:] 

Prepared Statement of Dr. Lee Zhong, MD, Ph.D. 

President, Elene Pharmaceutical Co. 

San Diego, California 

China’s Pharmaceutical/biotechnology Industry 

China’s pharmaceutical industry has been one of the fastest growing markets in 

the world during the past 25 years. Parallel to other sectors, pharmaceutical industry has undergone major changes, including consolidation and privatization of the 

state- and collectively-owned enterprises and an ever-increasing presence of the 

multinational pharmaceutical companies. China’s entry to the WTO has promised 

even greater growth for its pharmaceutical industry. 

Industry Overview 

China’s pharmaceutical market has been enjoying its dazzling growth over the 

past 25 years. According to China’s State Economic & Trade Commission, the average annual growth rate was 17% from 1978 to 2002, with estimated growth of 15% 

in 2003. The market for chemical drugs was worth around US$ 6.8 billion in 2000 

at ex-factory prices, which ranked seventh in the world (see Table 1). It is estimated 

that China’s pharmaceutical sector will continue to grow at double-digit rate over 

the next few years and become the fifth-largest market in the world by 2010 (see 

Table 1). China has emerged as one of the leading players among the pharmaceutical markets of Asia. Its market size and potential dominates the region. According to the International Medical Service (IMS), China will be the leading pharmaceutical market in Asia ex-Japan by 2005, with a projected 34% share. 

101 

Many factors are contributing to the fast growth of the industry. First, China has 

maintained political stability for the past decade. The government has been playing 

its part to help China’s pharmaceutical companies. Second, rapid and healthy economic development has strengthened the sector. The growth rate of GDP was 9.1% 

in 2003, with an average 8% annually for the past 20 years. Adding to the growth, 

foreign investment was strong, reaching US$ 53.5 billion in 2003. Third, a rapid 

growing aging population (over-65 population: 4.4% in 1975, 7% in 2000, estimated 

16% in 2030) and rising personal income has boosted the demand for pharmaceutical products. Lastly, the new technology development has also stimulated the 

industry. 

Besides the above factors that will continue to influence the pharmaceutical industry, healthcare system reform, which expands the general publics’ (such as peasants in remote countryside) access to healthcare, will play a key role in the development of the sector. 

Industry Compositions 

There are approximately 6,000 pharmaceutical companies in China, of which 

3,600 are chemical drug companies and 1,800 traditional Chinese medicine (TCM) 

ones. The market is highly fragmented, with top 10 companies only represents less 

than 10% of the market. The domestic companies share 65–75% of the market, and 

rest belongs to foreign invested companies and the imports. The chemical drug sector is the largest, with its output value make up 65–70% of the entire pharmaceutical industry, the TCM sector 20–25% and the Biotechnology sector less than 

10%. 

Chemical drug sector 

China’s modern pharmaceutical industry started in 1949 after the Peoples Republic of China was founded. In order to provide low-cost medicines to people, China 

invested heavily in pharmaceutical chemistry research. It aimed to imitate new 

drugs developed in the west and to develop more economical manufacturing process. 

This explains the characteristics of China’s pharmaceutical industry: strong in bulk 

pharmaceutical manufacture and weak at discovering and developing innovative 

drugs. 

Despite rapid growth, the range of Chinese drugs is limited and tends to focus 

in generics and pharmaceutical chemicals. Drug market profile is 15% over-thecounter (OTC), 62% generic, 14% branded generic and only 9% patented. Majority 

of the companies lack innovative R&D. 97% of synthetic medicines produced are copies. There is considerable duplication of production which results over-capacity. 

Despite of the problems of finished-dosage forms (FDF) sector, China has become 

a major player in the international bulk pharmaceutical market, owing to a large 

pool of pharmaceutical chemistry experience and talents as well as low labor cost 

(a tenth of that in the US). China exported 90% its bulk pharmaceuticals (active 


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pharmaceutical ingredients and intermediates), with the major markets being the 

EU countries and the USA. By the year 2000, China has become the second largest 

manufacturer and supplier of bulk pharmaceuticals in the world, with an output of 

537,000 tons of 1,500 different kinds of chemicals. 

Upon the WTO entry, China’s pharmaceutical companies have been pressured by 

the compliance requirements of ‘‘Good Manufacturing Practice’’ (GMP, a set of global 

industry standards for the medicine manufacturing process) and stricter restrictions 

on producing pirated drugs. The domestic drug companies were forced to change in 

recent years, mainly in two aspects: modernization and increase investment in research and development (R&D). Many companies have to evolve to survive the competitions from other companies, domestic and multinational, and to survive the new 

laws and regulations. The industry is also expected to change significantly owing 

to an increase in consolidation, alliance and acquisition. 

More and more companies are investing to upgrade their facilities for international regulatory compliance, especially for FDA approval. Steps have been undertaken by the Chinese authorities to encourage rationalization. Government required 

all companies to comply with standards of GMP by June 30, 2004. The number of 

the pharmaceutical companies is expected to reduce by half as a result of the policy. 

In the past, domestic companies paid little attention to drug R&D and instead focused on generics or pirated drugs. R&D expenses represent about 1% of their total 

revenue, against 15-20% in US. Due to the strengthening of Intellectual Property 

Rights (IPR) protection, companies are under the pressure to undertake innovative 

R&D, although the ‘‘R&D’’ conducted by the companies is often meant in the sense 

of producing higher quality products, with new formulations and indications. R&D 

spending of some companies has gone up to 5% of sales revenue. Many companies 

entered into strategic alliances with research institutes and universities since lacking their own facilities. 

TCM sector 

TCM has played an important role in the health care of Chinese and other oriental countries for thousands of years. TCMs are generally used for chronic diseases 

and many are OTC products. They tend to have fewer side effects. There are 1,800 

TCM manufacturers in China, with majority of them small or medium in size. Many 

of these companies have old machines. A major problem for TCMs is lack of standardization. 

Government policy has promoted TCMs to be one of the fastest growing businesses in the Chinese industry. Authorities designated TCM as special priority for 

industrialization and attempt to push TCM into international markets. TCM R&D 

are on two tracks, one is through the purification and standardization of TCM, the 

other is through the identification and purification of the active element(s) and development of small molecules, new chemical entities which may mimic the activity 

of the original product. The latter track presents opportunities to identify and 

produce novel Western-style medicines. 

TCM sector has generated little interest from multinational drug companies. The 

reasons include their current drug discovery practice, past disappointing experience 

with natural product screening and concerns over the IPR of TCMs. 

Biotechnology sector 

China has the capabilities to manufacture over 300 biotechnological products, including antibodies, vaccines, diagnostic reagents, etc. However, most of the products 

are generics—copy complex molecules by molecular cloning. 

Although China has conducted cutting edge biotech research, it lacks product-oriented R&D. This phenomenon is mainly caused by the original planning made half 

century ago. Basic research has traditionally been the responsibility of research institutes and universities. China has a number of world-class scientific biomedical institutions—the North and South Genome Centers, the Institute of Materia Medica, 

Tsinghua and Beijing Universities, etc. China has over 300 research institutes and 

50 early-stage companies for biotechnology and more than 30 of the 150 state key 

laboratories are focused on biopharmaceutical-related projects. Like chemical drug 

sector, we saw more biotechnological research undertaken in the industrial sector 

in recent years. However, most innovative researches, especially the upper-stream 

ones, are still conducted in the research institutes and universities. 

China has a large pool of knowledgeable scientists. There are some 200,000 researchers specialized in biotech R&D in China, some of them well trained overseas. 

A web of personal contacts with Chinese scientist working overseas also helps facilitate the transfer of ideas, personnel and funding back to China. 

One of the main reasons for the rapid growth of the sector is that the Chinese 

government has paid high attention to its development. Many funds have been set 

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up to finance biotech R&D, including the National Natural Science Fund, the ‘‘863’’ 

High-Tech Program and the Five-Year Plans. China has targeted biotechnology as 

one of the six key industrial technologies intended to fuel growth in the economy. 

Major investments in a number of major cities in China, including Beijing, Shanghai, Shenzhen are contributing to a growing interest in biotechnology joint ventures 

with western organizations as well increasing demand for biotechnology related 

products. As a result, there are many biotech industrial parks been built, which features collaboration of state research institutes, universities, and companies. 

One reason for the lag of industrialization of biotechnology, despite the impressive 

development of biotechnology research, is the scarcity of venture capital for new 

companies. In the past, the funding for domestic R&D was direct government support to state-owned research institutes and companies. Therefore, it made impossible and unnecessary to build a sophisticated venture capital market that enterprises hold the full risk and reward benefits. Authorities are taking steps to build 

a venture capital market; its result remains to be seen. 

Biotechnology Capabilities 

Biotechnology is the fastest growing sector in the past 30 years. Despite a late 

start (70’s) for its biotech development, China has made rapid progress in recent 

years and stands, in some areas at the international level. For example in gene 

mapping, transgenic technology for animals and plants, gene therapy technology, 

stem cell research, gene chips, etc. Listed below is a few areas. 

Human genome research 

Since the launch of Human Genome Project in 1994, China has achieved great 

success. It has built three top-ranked national genome centers. It was one of the 

six countries participated in the Human Genome Plan; together they sequenced the 

entire human genome. China’s human genome research has already been equipped 

with first-rate equipments and talented professionals. China is the most populated 

country in the world and its population is composed of many ethnic groups that are 

relatively isolated. This provides a precious genetic resource for studies on human 

genome diversity and evolution, as well as for hunting of human disease related 

genes. China is also carrying out genome projects of other species, such as rice, pig, 

etc. 

Genetically-Altered Plants 

China has been actively involved in agricultural biotechnology applications research for more than 15 years. It was the first country in the world to grow genetically modified crops when it planted transgenic tobacco in 1988. The need for technology to improve yield and food quality is essential in order to meet growing population demands. The rapid growth in the area also was helped by the limited opposition to the development of genetically modified organism foods in China, when compared with western countries. Scientists are working on various crops, vegetables 

and fruits. Research has somewhat slowed down due to increasing public opposition. 

Gene therapy 

China has scheduled to commercially launch a gene therapy, Gendicine, for treating head and neck squamous cell carcinoma. The product was developed in a biotech 

company in Shenzhen, Guangdong, and was licensed for marketing by China’s State 

Food and Drug Administration (SFDA). It is the first such clearance worldwide for 

any gene therapy. 

Animal cloning 

The first successful cloning in China was reported on June 22, 2000, a sheep 

called ‘‘Yang Yang’’. The fourth generation offspring of ‘‘Yang Yang’’ was born on 

February 6, 2004. In March 2002, they also reported the success in cloning a colony 

of cattle using fully differentiated somatic cells. This achievement was accomplished 

by Chinese scientists independently; it was a team of scientists at the Chinese Academy of Sciences Institute of Zoology and Zhongda Embryo Engineering Center. It 

was believed cloning technologies could be beneficial to future milk industrialization. 

Foreign Investment 

Overview 

China opened its pharmaceutical industry to foreign investment a couple of decades ago. Most multinational companies now have a presence in the market. While 

domestic players produce generics, foreign companies make or import their branded 

drugs. By the end of 2002, 1587 joint ventures (JV) have established in China, with 

investment totaling US$ 3.6 billion. 40% of all Chinese pharmaceutical enterprises 

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have utilized overseas capital. Among foreign companies, Xi’an Janssen Pharma (a 

Johnson & Johnson’s JV), Smighkline Tianjin and Sina-America Shanghai Squibb 

Pharma are the leading ones. Joint ventures and imported products accounting for 

roughly half the market in Shanghai and at least 30% of the nationwide market for 

synthetic chemical pharmaceuticals. 

In the past, although China opened its door for foreign companies, there were 

many unfavorable practices that hindered the development. Frequent policy 

changes, strong domestic protection, disregard for intellectual property laws, low 

profit margins and inefficient channels of distribution are common complaints of foreign participants in the market. Upon joining the WTO in late 2001, China has 

made improvements in the intellectual property environment, lowered tariffs and 

gradually opened its drug distribution and hospital sectors to foreign participation. 

The new laws/policies/regulations provide better environment for international 

companies and increase the attractiveness of China’s pharmaceutical market. The 

foreign investment has increased. For example, Bayer Materials Science, the multinational chemical giant, announced in November 2003 that for the years up to 2010, 

they would allocate 75% of its global strategic investment to the construction of production facilities at Caojing, Shanghai. The total investment is expected to be US$ 

3.1 billion. 

Trend 

Although the average of tariff rates on imported drugs has been lowered significant after WTO accession, we do not expect to see dramatic increase in drug importing. Because of low cost labor, foreign companies prefer to continue their manufactures in China. Plus, most of multinational drug companies have already built their 

plants in China, some even their R&D divisions. 

The multinational pharmaceutical companies are increasingly conducting R&D in 

China, by collaborating with domestic research institutes and companies or by establishing their own centers. It is in the mutual interests of both sides. While Chinese need help in identification and development of innovative drugs, foreign companies enjoy the low cost. The average cost of a chemist in a US contract laboratory 

is US$ 200,000 per year, with an equivalent chemist in China costing US$ 50,000. 

The State Economic and Trade Commission (SETC) supports foreign pharmaceutical companies in expanding their business from manufacturing to R&D, and 

setting up centers to develop new products together with domestic institutes and 

hospitals. Foreign-funded research centers would be exempt from import tariff and 

custom taxes; business taxes would also be exempt if foreign companies transferred 

technology to China. 

Concerns 

There are multi-level regulatory bodies in charge of the whole system. The State 

Food and Drug Administration (SFDA) oversees the whole industry including setting regulations & policies and Evaluation and approval new drugs, generics, and 

imported drugs. The State Development and Planning Commission (SDPC) sets 

drug prices. The State Economic & Trade Commission (SETC), along with SFDA decides which drugs are eligible for reimbursement. It forces foreign companies to 

keep solid relationship (Guan Xi) with these government bodies, which requires a 

huge input of time and resources. It can also be difficult for foreign companies because of the culture barrier. 

In order to provide their citizens with affordable medicines, drug prices, including 

those of drugs on the basic reimbursement list and patented drugs, are regulated 

strictly in China. Many drug makers are forced to make difficult decision to either 

keep the price high and off the list of reimbursement, or cut the price to be included 

on the list. Furthermore, relevant government bodies are generally encouraging, 

sometimes commanding doctors to prescribe low-cost generics. This works against 

multinational drug companies, most of which sell high-end branded drugs at premium price. 

There are also fears that China’s economy is overheating and concerns of whether 

the Chinese currency Yuan will be devalued. 

Intellectual Property Rights Protection and New Drug Regulation 

Before the reform of patent laws in 1993, China did not acknowledge intellectual 

property of medicines and no patent was granted for the innovative drugs. After 

1993, China agreed to provide administrative protection for certain patented drugs 

in China. However the execution was problematic. The data submitted to the SFDA 

as part of the approval process was often intentionally leaked to domestic companies, which allowed domestic producers to use information to gain marketing authorization for copied version while foreign companies were waiting for their approval. 

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Since its accession to the World Trade Organization (WTO) in December 2001, 

China has built up a relatively good intellectual property rights (IPR) system by 

promulgating many laws and regulations in field of IPR. These include the Patent 

Act, Trademark Act, Copyright Act, and Trade Secret Act. China has repealed a 

total of 2,300 laws and regulations that were deemed incompatible with WTO requirements. China regards IPR protection as very important to the pharmaceutical 

industry. 

For new drug registration, China has issued relatively good administrative laws 

and regulations. Its latest version, which published after China’s accession to WTO 

in 2002, is compliant with international standard. Among these were regulations expected to bring requirements for local and imported drugs more into line, reducing 

average approval times. 

China has achieved a great deal in IPR system within the past decade, especially 

in recent three years. However, IPR remains a serious problem. There are several 

problems involving administrative protections, the relationship between medical registration and patent protection. Foreign companies still complain about losses from 

counterfeiting. We believe the main problems are underdeveloped awareness of domestic companies and insufficient obedience in some local regions. Of course there 

are rooms for intellectual property laws and relevant regulation policies to be fine 

toned. 

Summary 

China’s pharmaceutical industry is evolving. Chinese government appears to be 

determined to build the country into a major player in the sector. Through a number of important measures introduced, China has started to establish a firm base 

on which to develop a globally competitive research-based pharmaceutical industry. 

The rapid economic growth and increasing demand for medicines will stimulate sector’s growth. 

Because of implementation of GMP and tightened IPR protection, we expect to see 

increasing consolidations of domestic companies. As a result, the capacity and capability of domestic sector will be heightened. Modernization of the generics and traditional Chinese medicines sectors will be undertaken. And biotech industry will likely 

to evolve towards industrialization. It is possible to imagine the appearance on the 

global scene of novel Chinese-originated medicines. 

The market presence of multinational pharmaceutical companies will continue to 

be in the mutual interest of’ both sides. Because of the current favorable environment for foreign investment, we expect to see foreign companies to increase their 

investment, not only in drug manufacturing but also in R&D. Foreign companies 

would also have a better opportunity to gain a greater share of the Chinese market. 

Co-Chair ELLSWORTH. Thank you, Dr. Zhong. Dr. Dance, please. 

STATEMENT OF KERRY DANCE, PhD., MANAGING MEMBER 

HAMILTON APEX TECHNOLOGY VENTURES, LP 

Dr. DANCE. Okay. Thank you members of the panel and, Bob, of 

course, for getting me roped in. 

I do represent the venture capital industry, which is very strong 

here in San Diego. So let me just take a second and say, what is 

venture capital? 

It’s basically the bridge between somebody that has an idea, he’s 

put some time and money in, he may have got government grants, 

but he now wants to form a company, but he doesn’t have any profits. He can’t go to a bank and get any money. That’s where venture 

capital steps in and funds. It’s intrinsically a high-risk, high return—we hope high return—kind of business because we’re investing before sales, certainly before profits and often before there’s 

even a product. 

It’s also a little bit of a cutthroat business. And the companies 

that come to us often refer to us as vulture capitalists as opposed 

to venture capitalists. 

There have been many studies, though, that show the singlemost important dollar for putting forth to getting wealth and jobs 

106 

is the venture capital dollar. You get tremendous leverage out of 

it. 

This fact has been recognized by the U.S. Government. The 

Small Business Administration has a program that provides funds 

to venture capitalists under the so-called SBIC Program, and Hamilton is a hundred-million-dollar SBIC fund. We are one of those 

groups that gets part private capital and part from the government. Right now there are about 1500 venture capital firms in the 

United States that represent about $10 billion a year investment. 

During the peak of the dot-com phase, that was $80 billion a year. 

It’s a hallmark of the United States. There really is no other 

country that has the venture capital structure of the United States. 

It goes with the innovation of this country. Most major biotech 

start-ups that you see now had initial venture capital funding to 

get them started. Amgen, Genentech—those very large wealth creators and job creators had venture capital in their beginning. It’s 

not been overlooked in many other nations that you tend to get a 

lot of wealth and a lot of jobs out of both biotech and venture capital, and Asian nations are trying to emulate the USVC structure. 

Korea, in particular, made a significant government effort several years ago towards creating a venture capital structure in 

Korea. It was not very successful. 

One of the problems is that to have venture capital be successful, 

you have to have a lot of innovation. You have to have a lot of 

ideas to look forward. You have to have a lot of management, people that have run entrepreneurial companies. You have to have the 

money. And you have to have ways to getting an exit. If those 

things all don’t coincide in one place—and they didn’t in Korea— 

you can make investments in VC; you can’t get your money back. 

It fails. 

So Korea is now investing—allowing investments, which they 

didn’t initially, in U.S. venture capital firms to kind of learn the 

business more and to realize to deploy their money, they have to 

put it again in areas. That, by the way, is a hallmark, also, of the 

United States. The successful VCs tend to be very clustered in 

areas that have the innovation and the people and all that. So most 

of your VCs are in Boston, the Bay Area, and San Diego. It’s hard 

to make big VC business in Fargo. There just are not all the attributes there. China has been very interested in biotech, in particular in the VC business in general. It has no formal program 

such as Korea. However, it is allowing people and individual investors—the largest single investor in Hamilton’s fund is from Mainland, China. 

Biotech interest in China. China, as previously mentioned, has 

largely been overlooked by Big Pharma because there was no IP 

protection in pharmaceuticals, and in biotech IP is king. There is 

new interest in China now by biotech firms here, both looking for 

traditional Chinese medicine and trying to find out why it works 

and making a western drug out of it. 

It’s also a large market, as mentioned. There’s 10 percent of the 

Chinese that can afford to pay more than $15. Can afford to buy 

western medicine. And 10 percent of China is, in fact, a very big 

market. And it’s a very big pool that several companies are looking 

107 

at as a place to do trials, get a lot of people and do trials a lot 

cheaper in big pharma trials. 

So there is going to be a convergence of U.S.-China interests. I 

expect to see more biotech involvement in China, biotech and 

pharma, and more investment by China in biotech here in this 

country to learn and to get a foot in the door. 

And China will continue to probably make some investments in 

the USVC structure, venture capital structure, but I don’t think 

anything is going to come quickly that really has them set up, the 

kind of structure that we have in the United States at a formal 

government level. 

What about investor influence on U.S. venture capital? First, in 

the venture capital business, the people that give us money really 

have almost no influence on what we do. It’s kind of—by the legal 

structure, they cannot make fund decisions. 

Our companies that we fund make very limited disclosures to the 

investors. They don’t give away proprietary information. And, quite 

frankly, a Chinese investor is not a primary investor. Getting 

CalPERS or something like that to invest in your firm is about 

power, clout. CalPERS might be able to get some special rights; 

right now Asian investors won’t. Co-investment rights for the limited partners to get special interests or something, a company, are 

not given in general because that potentially ruins the value of our 

investment. We do have co-investment rights with investors. And 

one—our Chinese investor has co-invested in a company that’s 

doing a cancer drug development with us; but, again, he has no 

special rights in the company. 

Some of the questions that obviously come up is, will China continue and move forward in honoring biotech IP? Are the Big 

Pharma companies and biotech companies here going to feel really 

comfortable to move into the market and have their patents protected? And how fast is China going to represent a market? 

Everybody’s looking, and obviously, everybody would like to sell 

more in China, help to balance the trade. How fast is it going to 

happen? And then how fast has China learned? Is it going to turn 

around and bite you on the other side? That besides being a market, they suddenly are a major competitor. Whether China is going 

to try to create a venture capital structure to emulate the U.S., I 

think that will come, but I don’t think that’s going to happen in 

the next several years. And what are the security concerns of 

biotech? Biotech in particular offers probably more hope than a lot 

of things for all of us that are getting older and getting all kinds 

of diseases. You’re seeing an amazing convergence of science and 

technology to help us all out across the board. 

On the other hand, like all technologies, it can be misused. And 

almost all those biotech innovations can potentially lead to bioterrorism kind of things. 

And so as China moves into the whole biotech field, can we get 

the benefits, can we get the market or what are the risks that come 

with that? That is a question. 

Thank you. 

[The statement follows:] 

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Prepared Statement of Kerry Dance, Ph.D. 

Managing Partner, Hamilton Apex Technology Ventures, LP 


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Co-Chair ELLSWORTH. Thank you, Dr. Dance. 

Commissioner Becker and Commissioner Wortzel have indicated 

that they have a question, but I think, unless you really want to 

intervene here very briefly, I think I will just move on down the 

table. 

What do you say? Okay. Mr. Panetta. 

STATEMENT OF JOSEPH PANETTA, PRESIDENT/CEO, BIOCOM 

Mr. PANETTA. Thank you, Chairman Ellsworth, and members of 

the Commission. It’s a great pleasure to come before you this afternoon and to be here with this panel, as well. As Commissioner Ellsworth said, I’m president and CEO of BIOCOM. BIOCOM is the 

largest regional and state association for the life sciences industry 

in the country. And we represent some 500 members here, member 

firms, with about 500 companies in San Diego involved in biotechnology and biomedical science. We represent the third-largest 

cluster of biotechnology in the United States, following the Boston/ 

Cambridge area and the San Francisco Bay Area. 

The industry here in San Diego is relatively young in comparison 

to the other clusters. We got our start about 25 years ago, but it’s 

only been within about the last 15 years that we’ve seen an exponential growth in biotechnology companies here in San Diego. 

Along with that lack of maturity of our companies comes a lack 

of global penetration in terms of having products on the market 

and global partnerships. 

So one of the objectives of our organization, BIOCOM, is to position this region’s life science industry on the global stage so that 

we can achieve individual success within our companies and collective success for the biotechnology industry in San Diego. We believe 

that there is greater opportunity in terms of research and technological innovation here in San Diego than in the other clusters and 

in the development of the products that these companies are creating to improve health and to improve quality of life. 

So what we’re doing here in San Diego with our member companies and member firms through this association is to focus on an 

environment where we can have legislative policy, regulatory action, resources, economic conditions and a public awareness globally that will influence the further growth of the biotechnology industry. As you’ve heard from our other panelists, we expect to see 

health care change dramatically in the 21st century as a result of 

biotechnology and leveraging the successes that we’ve seen, particularly with the sequencing of the human genome. 

And scientists here in San Diego and all over the world in biotechnology are working to better understand gene structure, gene 

function and the interactions between genes. So we look at this 

21st century as the age of biology. And we feel that we probably 

have an entire century here of work that we can do to further create products through the technology that our industry offers. 

Success means, as you’ve heard, delivering products to patients, 

improving health, and improving quality of life. And it’s not only 

in the field of medicine; biotechnology has broad applications in the 

industrial sector, in the agricultural sector, in the environmental 

sector and others, as well. 

117 

We haven’t had much direct experience in the development of the 

biotechnology sector in China. So I’m really not able to characterize 

much for you in terms of San Diego’s experience in China. But I 

can tell you that our interest in China is becoming significant, and 

it will continue to develop in the future with the development of 

our global marketing interest as BIOCOM. Within the past few 

years here we have seen the presence of a number of delegations 

from throughout China with an interest in investing in San Diego, 

in partnering and licensing technology and, as Dr. Zhong said, in 

accessing the innovation that is going to be required in order to 

continue to grow the industry that China hopes to grow. 

While in the past China’s healthcare system has not been viewed 

as one of tremendous potential for pharmaceuticals and even for 

biotechnology products, as Dr. Dance said, this is changing with 

the rise of a more affluent class within China. And regardless of 

the fact that government subsidy doesn’t provide the level of reimbursement that we might see here in the United States and in Europe, in Japan for biotechnology products, the level of affluence 

there provides greater opportunity for the population to access 

these drugs on a per-capita basis that rivals the United States and 

rivals Europe, as well. So we certainly see greater opportunity 

there. Since the mid 1980s, in surveys that have been done relative 

to health care in China and the prevalence of disease in China, 

what we’ve seen is that it’s similar to the industrialized world in 

terms of cancer, cerebrovascular diseases and cardiovascular diseases, as well. And some of the most prevalent forms of cancer also 

are similar to the other areas in the world, such as lung, liver, and 

esophagus. And China has also recognized, we know, that the 

threat of AIDS is a global threat and joined in that global fight 

against the disease. All areas that the biotechnology industry is 

working to develop products in. 

What is attractive to this industry is to be able to expand into 

regions of the world where price controls will not negatively impact 

market opportunity. 

As you may know, this is an industry that requires tremendous 

investment. The average cost of bringing a new drug to market 

varies somewhere between $500 million and $800 million, and that 

investment is over the course of 12 to 15 years. Now, with patent 

protection of 20 years from the date of application for a patent, 

that doesn’t allow for a lot of time for return on the investment. 

So the importance of free market economy comes into play tremendously. The other issue that comes into play tremendously here is 

that of intellectual property protection. And I won’t reiterate what 

has already been said on that issue. We know that China is making tremendous strides in terms of changing laws to further ensure 

intellectual property protection, but our concern there is enforcement and whether there will be the degree of enforcement that’s 

necessary to protect these valuable intellectual properties and inventions that are the lifeblood of biotechnology companies remains 

to be seen. So that’s a great interest to us and great concern to us, 

as well. 

I appreciate the opportunity to come before you this afternoon. 

Those are our main issues. We do see tremendous opportunity here 

and look forward to your questions. Thank you. 

118 

Co-Chair ELLSWORTH. Thank you, Mr. Panetta. Mr. Lucier, 

thank you for coming down and joining us, and we look forward to 

hearing from you now. 

STATEMENT OF GREG LUCIER, PRESIDENT/CEO, 

INVITROGEN CORP. 

Mr. LUCIER. Thank you, Commissioner. My name is Greg Lucier. 

I’m president and CEO of Invitrogen, which does roughly one billion dollars a year in sales in tools and technologies supporting 

biotech research all over the world. We’re based here in San Diego, 

and we’re one of the largest biotech companies in terms of market 

capitalization in the world. To give you my perspective, we do export into China millions of dollars a year of tools and technologies 

to support their biotech research, and we have a very large team 

across China on the ground supporting our business there. What 

I can do is provide you a perspective on biotech research and 

what’s going on in that country in terms of their development of 

this industry as a direct participant. 

It began, as you know, about two decades ago as part of the 863 

program for their investment in high tech. Currently the government of China is supporting biotech directly in terms of their investments into universities, research centers and labs to the tune 

of about $600 million a year. And so when we look at China, we 

think it has probably one of the most developed sets of scientific 

communities that we see outside the United States, and is really 

quite strong in terms of agricultural biotech and gene therapy. . To 

give you some perspective of their achievements over the last six 

years, they were one of the six countries involved in the Human 

Genome Project, and continue to decode genomes even today that 

are available to the research community around the world. And, in 

fact, just recently the Chinese introduced a complete genome for 

rice, which was a very important development.. 

They are also one of the first to market a commercially available 

gene therapy drug called Gendicine, which supports and deals with 

a particular type of cancer. So they are really on the cutting edge 

of gene therapy as we see it. And importantly in the area of agricultural biotech with 20 percent of the world’s population and only 

7 percent of arable land, they are heavily investing in agricultural 

biotechnology research and rank fourth today in terms of crops 

under cultivation using genetically modified seeds. 

So it’s a very strong industry. It’s growing incredibly rapidly. 

And just to give you a feel for where it’s going next, the government recently just announced $250 million on an annual basis to 

support nanotechnology research. And perhaps we could get into it, 

but the intersection between what we do in terms of biotechnology 

tools and nanotechnology are very, very close. So we see ourselves 

as ultimately becoming a nanotechnology company, as well. And so 

what I can say a few words about is, is there a development, will 

there be a development of a commercial biotech industry in China? 

On the commercial side of the biotech industry, we see things as 

being very early stage, nascent if you will; quite frankly, it is still 

not a viable as an industry as we know it...just yet. We see countless commercial companies trying to sell to us technologies because 

they are unable to get the money they need to stay viable. And as 

119 

my previous colleagues suggested, it’s really due to a number of different issues, one of them being the fact that the domestic market 

for biotech products is still very young. However, I would just tell 

you I spent most of my career at General Electric, and in a matter 

of five years’ time we were able to build a billion-dollar business 

around diagnostic imaging and other medical products. So there is 

a very fast-growing affluent health-care population coming in 

China that will want the type of very expensive drugs that come 

out of biotech research. 

So people see it. It’s just a question of when these drugs will be 

available and when the money will be there to really support that 

industry; but that day is coming, and I would tell you it’s coming 

fairly quickly. 

So beyond just the need for the development of a therapeutic 

market that could support these drugs, as the other participants already talked to you about, there is still a lack of commercial sophistication in managing biotech companies; we have that here in the 

United States as well! And then also, just protecting intellectual 

property is still very much an issue, as we talked about before. So 

when we look at China, just to give you where we’re going next in 

terms of Invitrogen as a company, as I said before, we do millions 

of dollars a year exporting into China. And one of our key initiatives for 2004 is to set the groundwork to make that into well over 

a $100 million business in the next couple of years. 

We see several ways to do that. The first is that the regulations 

of China are actually helping us. The government is greatly easing 

the trade restrictions that will allow us to more directly participate 

in the country in terms of biotech. And so whether it’s through acquisitions and acquiring a number of these different companies 

that do exist in China, or investing in our own production in China, 

we see it as being a very strong domestic market for internal consumption/demand but also exporting to other countries around the 

world. 

Between the low-cost labor and the high intellectual capabilities 

of this country and its people, this is a terrific place to place your 

business. 

So we see China as both a good market and a good export location for Invitrogen to continue its expansion. 

Thank you very much. 

[The statement follows:] 

Prepared Statement of Mr. Greg Lucier 

President & CEO, Invitrogen Corporation 

Executive summary 

Chinese investment in biotech began almost two decades ago as part of the now 

legendary ‘‘863’’ program for investment in high tech. This investment (currently 

∼$500–600 million/yr) has created a strong R&D infrastructure of research institutes, labs, centers and universities. In addition, China also has a highly technically 

trained workforce that can conduct high quality R&D at a much lower cost than 

labs in more developed countries. These investments have established China as a 

strong player in genome sequencing, ag-biotech and gene-therapy. They should also 

provide a strong platform for future growth. 

Commercial biotech enterprise, however, is still not a viable industry in China. 

Although China has mastered many of the basic technologies, it is still seen as lacking a ‘‘product’’ mentality needed to get new drugs/products on the market. Most of 

the existing biotech companies are small, starved for funding and pursue ‘‘knock 

offs’’ of products developed elsewhere. They are also almost wholly dependent on 

120 

government sponsored R&D. Private capital investment (either VC or stock market) 

in Chinese biotech is very low due to a lack of clarity of regulations, inadequate 

legal infrastructure to enforce existing laws, insufficient financial infrastructure to 

guarantee security and retrievability of investment, and lack of public understanding of biotechnology. Foreign investment is also hampered by insufficient protection of intellectual property (IP). Although, as part of entry into the WTO, China 

has adopted patent laws that are more aligned with the more developed countries, 

enforceability of these laws could be further strengthened. The development of local 

biotech is also hampered by the lack of high caliber management—individuals with 

both management skills and a deep understanding of biotechnology. 

China’s large, increasingly affluent and health conscious population presents a 

huge market opportunity for biotechnology oriented companies in developed countries. China’s biotech market is estimated to be ∼$$3 billion currently and is expected to grow at ∼$13.5% annually to reach ∼$$9 billion in 2010. The main sources 

of growth are likely to come from areas such as ag-bio, genomic sequencing, 

biochips, leveraging leads provided by Traditional Chinese Medicine, Bioinformatics, 

stem cell research, bio-manufacturing and toxicology testing. Growth could be even 

higher as IP protection strengthens, financial, legal and regulatory infrastructure 

improves and there is more influx of foreign investment and managerial talent into 

the Chinese biotech industry. There is currently little evidence of Chinese companies investing in overseas biotech as a means to acquire technology. China, however, 

may be gaining access to technology and superior managerial talent by successfully 

attracting and repatriating Chinese scientists that have been trained abroad or are 

working in overseas biotech companies. 

Invitrogen has a long history in China and remains committed to a continued and 

strong presence there. Invitrogen first entered the Chinese market in 1979 and continuously distributed its products through local distributors since that time. Given 

the recent easing of direct trading regulations, Invitrogen is presently considering 

several options to create a Chinese subsidiary. It expects to more than quadruple 

its current sales in China over the next five years. Beyond supporting cutting edge 

research in both medical and ag-biotech, Invitrogen plans to explore opportunities 

to source raw materials from and to conduct activities such as manufacturing and 

media development in China. 

1) Assessment of the current technological capabilities of the biotechnology sector 

in ChinaChina has had a long history of investment in biotechnology. China’s 

biotech program was officially initiated in 1986 by Deng Xiaoping, with a declaration that biotechnology was one of the seven technologies critical for economic 

growth. Biotechnology was funded as part of the now legendary 863 program (so 

named since it was begun in March of 1986) and has had increasing government 

funding outlays in each of the successive 5-year plans. It is estimated that the Chinese government spends upwards of $600 million per year on biotech R&D through 

its various institutes and academic centers. The total biotech market in China inclusive of all sectors is estimated to be $2.80 billion in 2001 and is expected to grow 

to ∼$$8.78 billion by 2010 (CAGR of 13.5%). 

Initially, China concentrated its efforts on agricultural biotechnology, as a means 

to self sufficiency in food. The challenge is particularly large for China, since it has 

20% of the world’s population with only 7% of the world’s arable land. In 1988, 

China became the first country to commercialize a bio-engineered tobacco plant resistant to a plant virus. Since then additional research has yielded virus-resistant 

tomatoes, sweet peppers, peanuts, cotton, papayas. Today, China ranks fourth in the 

world in total area under genetically modified organism (GMO) cultivation after the 

US, Argentina and Canada and has developed many transgenic crops. As many as 

60 plants are reported to be under research across more than 90 research institutes 

around the country. Research is also being conducted on more than 30 varieties of 

GM fish and animals. Animals under research include hogs, cattle, sheep, and domestic rabbits. Scientists have started research using GM animals to produce medical protein. GM microorganism for use in the production of feed additives, vaccines, 

and pesticides were developed as early as 1999. In addition, China has proven its 

capabilities in cloning animals. While in the past, cloning has focused on cattle, 

China is now attempting the cloning of the Giant Panda. 

China has had a lot of success in the medical biotechnology field as well. China 

was one of the six countries involved in the Human Genome project, and successfully sequenced 1% of the human genome. Recently, Chinese scientists published the 

draft sequence of a rice genome—a task achieved in a remarkably short amount of 

time, beating an international consortium whose efforts had commenced considerably earlier than China’s. This feat underscored the country’s ability to reach the 

highest level of science while facing the array of economic and political challenges 

often facing developing countries. Chinese scientists have also completed genome seVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00126 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
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quencing of a number of microbes such as Leptospira icterohaemorrhagiae, Staphylococcus epidermidis, Shigella flexneri, thermophilic bacteria, which have played an 

important role in improving the understanding of disease-triggering mechanisms 

and development of medical vaccines. About 20 bio-pharmaceutical products have 

been commercialized so far, including recombinant medicines and vaccines. Thirty 

more are in clinical trials. The major products of the industry are 

immunodiagnostics, research reagents for biotechnology laboratories, animal vaccines, human vaccines, Colony Stimulating Factors (CSF), erythropoietin (EPO), 

monoclonal antibodies, medical material supplies, and feed additives. In late 2003, 

SiBiono GeneTech received approval to commercially market Gendicine, a gene-therapy based treatment for nasopharyngeal cancer. New Scientist reports this to be the 

first approved gene-therapy treatment in the world. The treatment delivers a 

healthy copy of the anti-tumor p53 gene through a simple adenovirus construct that 

does not integrate into the genome of cells. The cost of a single dose of therapy is 

expected to be only $360. 

The successes already achieved by China in the area of biotechnology are a result 

of three major sources of strength. 

1) Availability of research talent: China has a large pool of more than 50,000 talented research scientists in biotech industry. Unlike countries such as Malaysia and 

Singapore, China has a history of scientific research, and hence, has built its talent 

base over a 20-year period. Through its strong educational infrastructure China is 

expected to grow this pool by about 4500 scientists each year. In addition, China 

is also providing strong incentives to attract Chinese researchers that have been 

trained abroad. China now offers all returning doctoral degree holders at least associate professorships, and other material benefits. As a result, China’s talent pool is 

quickly achieving world-class status. Not only is this research pool highly qualified, 

it is estimated to cost less than a fifth to a tenth that of comparable US talent. 

2) Strong government support: The Chinese Government actively supports the biotechnology industry as part of its High Technology Program and has reportedly increased its investment in biotech to ∼$$500–600 million. Biotechnology features 

prominently in its agenda of developing knowledge industries. In fact, government 

funding supports a majority, if not all, of biotech R&D in China. 

3) Research infrastructure: China has several research institutes, research centers, 

universities and laboratories that provide the necessary infrastructure for biotechnology research. The Ministry of Science and Technology (MOST) directly funds 

most of these and also sets overall strategy for all government-funded biotechnology 

research. The China National Center for Biotechnology Development is a purely administrative body and is mostly involved in activities to promote biotechnology and 

the allocation of government funds. The Chinese government has also set up technology parks, the largest being in Shanghai and Beijing, to promote commercial biotechnology development. The key institutions/organizations forming the R&D infrastructure include: 

• Chinese Academy of Science (CAS)—based in Beijing—China’s highest academic 

institution and comprehensive research center in natural sciences. CAS’s 

Lifesciences and Biotechnology Division controls 24 research institutes, 13 research centers and 26 key State laboratories across the country. It employs 

more than 6,000 research scientists and has a biotech-specific budget of $90 

million (15% of CAS total budget) 

• Chinese Academy of Agricultural Sciences—based in Beijing it is involved in 

basic research and spearheaded effort to genetically engineer cotton resistant to 

the bollworm in early 1990’s (bollworm infestation responsible for $630 million 

crop loss in 1992–3 alone) 

• Beijing Genomics Institute—Has been heavily involved in sequencing of the rice 

genome and boasts one of the largest gene-decoding operations with 500 staff, 

100 sequencers, 4 supercomputers. It is currently working on genome for dates 

and cassava 

• Tsinghua University—Beijing—houses major biochip lab 

• A professor at the university developed a miniaturized ‘‘lab on a chip’’ 

(biochip) system for use in drug research and disease diagnosis which then 

became seed for U.S. start up biotech co Aviva Biosciences in San Diego with 

venture capital came from Taiwanese sources 

• The same professor, along with researchers from several other Chinese institutes, has started a Beijing-based company called Capital Biochip which focuses on biochips and improving the manufacturing process of the chips. It 

is also working on DNA library, databases and bioinformatics. Capital Biochip 

received a total of $47 million in venture capital, some of which was funded 

by the Chinese 

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• Beijing University • Shanghai Institutes of Biological Sciences—composed of 8 CAS institutes and 

two research centers in the Shanghai area • Chinese National Human Genome Center at Shanghai—established in 1998, the 

center sponsors research into a variety of areas related to the human genome 

(specific examples include cloning and gene expression) • Shanghai municipal government is building a pharmaceutical/biotechnology 

complex in Pudong • China’s largest international biotechnology park is being built in Hangzhou 

(near Shanghai) • Hangzhou University of Science & Technology • China National Rice Research Institute, Huangzhou—spearheaded China’s biggest genetic effort focusing on rice—engineering higher yielding rice plants 

which are more resistant to drought and insects • South China University of Technology • University of Science and Technology of China 

Despite the R&D successes, however, biotechnology is still not a viable industry 

in China. Although, China has ∼$150 biotech companies (40–50 publicly traded and 

the rest privately funded or government funded), most of these are very small and 

starved for resources. Most do not engage in cutting edge R&D and in addition, 

most of the products are knock-offs of US products due to historically weak patent 

protection in China. Due to intense competition in production of knock-off products, 

revenues and margins tend to be very low. Venture capital activity, which provides 

the majority of early stage biotech funding in the US, is very low in China. Most 

of VC funding in China comes from government or university VC, and is often 

linked to spin-offs of technology developed at universities. Foreign VC investment 

in China tends to be low due to a perception of inadequate exit options for any investment. 

There are around 20 biotech-derived drugs in the market that are mostly Chinese 

adaptations of western products. In addition, since Chinese companies often lack the 

necessary quality standards, sales are limited to the Chinese market. Profitability 

in the industry is razor thin owing to a high level of competition and government 

price controls. 

There are a few key factors that contribute to China’s weak biotech industry: 

• Weak IP protection: Prior to joining the WTO in 2002, China did not recognize 

product patents. This made it a very unattractive environment for an IP-heavy 

industry such as biotech. China’s move into the WTO now compels it to recognize international patent laws (including product patents) but enforcement of 

regulations is still seen as an issue • Lack of private funding: China’s biotech is almost entirely funded by the government. Accurate market information is often hard to find and regulatory hurdles have kept foreign investments low. Insufficient exit strategies keep VCs 

away from the Chinese biotech market. In addition, the Chinese stock market 

allows only limited opportunities for the VCs to sell their shares. • Inadequate management skills: Success in the biotech industry requires a combination of, management acumen and scientific understanding. The Chinese biotechnology industry has not yet received its fair share of management talent 

and is generally viewed as not having a ‘‘product mentality’’. Management education is only recently catching up in China and managers with international 

exposure who understand the intricacies of the biotech business are hard to 

find. • Price controls in the healthcare market and poor distribution infrastructure 

may also be contributing to weakness in the biotechnology industry. 

2) Prediction on how the sector will develop in the future. 

China is widely expected to become the one of the largest markets in the world 

and the biotech market is expected to grow strongly as well. It potential can be 

gauged through a few interesting anecdotes: 

• Sales of genetically engineered drugs and vaccines have grown at an annual 

rate of ∼80% between 1996 and 2000. • China’s population of 1.3 billion currently consumes only $7 of health care products per capita vs. $220 for U.S. (per Ernst & Young). Spending on healthcare 

will increase as Chinese per capita income continues to improve. 

• China spends only 4.5% of its GDP on healthcare as compared to 12.9% for the 

US, 6.9% for Brazil, and 5.1% for India. 

• Although China is already the fourth largest producer of GM crops, it currently 

accounts for only about 1% of the global acreage planted with bioengineered 

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crops (per International Service for the Acquisition of Agri-biotech Applications—a Philippines non-profit) vs. 68% for the U.S. share. • To be self sufficient in food, China has to feed 20% of the world’s population 

with only 7% of the world’s arable land. 

Frost and Sullivan expects the Chinese biotechnology market to grow at about 13.5% annually, from $2.8 billion in 2001 to $8.8 billion in 2010. Substantial 

amounts of this growth will come as more MNC’s conduct more R&D and production 

activities in China, to take advantage of the talented yet cheap labor pool. Growth 

will also be helped by the improving IP situation and continued government openness to foreign investment. This should also lead to increasing collaborations with 

international research centers and global pharma and biotech companies. China 

could play a big role in several potential areas, including: 

• Ag-Bio is expected to be a continued focus of government funding as it looks 

to find crops that have higher yield, greater nutritional value, increased disease 

resistance, and can grow in ‘‘unfavorable’’ climates/soil conditions. • Gene sequencing and Biochips: China will likely continue its prowess in gene 

sequencing and capitalize on the biochips market. These chips have helped to 

cut diagnosis time for many illnesses greatly and proved invaluable in gene expression studies. Diagnostics and pharmacogenomics will become increasingly 

important as the Chinese population becomes more health conscious and has 

more disposable income to spend on healthcare. The need to quickly identify 

control infectious diseases (e.g., SARS) will also promote greater investment in 

this area. Biochips are not restricted to medical biotechnology, but find many 

applications in fields such as biochemistry and environmental protection as 

well. Since 1997 several national engineering research centers with strong professional expertise in research and development of biochips and related products 

have been established to commercialize biochip development. They include: Beijing National BioChip Research and Engineering Center (BNBREC), Shanghai 

Biochip Co.Ltd., (SBC) & Shanghai Engineering Center for Biochips, and The 

National Engineering Research Center of Miniaturized Detection Systems. In 

addition, there are also several private companies that are in this space including: Capital Biochip, Shanghai Biostar Genechip Inc, Shenzhen Yishengtang Biological Product Co., Shaanxi Chaoqun Science & Technology Co., Shaanxi 

Chaoqun Science & Technology Co., and Shanghai Huaguan Biochip Co., Ltd. 

The State Drug Administration (SDA) in China has approved some of these 

companies’ biochips for medical diagnostic use for production and clinic use. • Leveraging traditional Chinese medicine (TCM): Several companies and research institutions are conducting research to identify the active chemical entities of the vast number of TCM remedies. Since these formulations have been 

proven successful over thousands of years, the effectiveness and safety of the 

active ingredients of these drugs should be easier to prove. 

• Bioinformatics: China has established several leading bioinformatics institutes 

(e.g., Beijing Genomics Institute—Genomics and Bioinformatics Center). These 

institutes are focused on general and specialized database construction and 

services, in-silico cloning, and customized development of data analysis tools for 

post-genomics research. Work is ongoing for an integrated data warehouse system of proteomics research. These institutes have substantial infrastructure, including Chinese-made supercomputers. Bioinformatics prowess was instrumental in sequencing the rice genome. Bioinformatics in China is poised for significant growth in the future as it has the necessary ingredients for success in 

this area namely, people with good training in biological sciences and computer 

science. 

• Treatment for and vaccines against diseases that are prevalent in China, e.g., 

head and neck cancers, hepatitis B, liver cancer, SARS, etc. 

• Stem cell research: While the United States has severely limited government 

funding for stem cell research because of ethical concerns, China, along with 

several other countries, is likely to focus on fully reaping the benefits of R&D 

in this emerging field. In fact, in March 2002, the Wall St. Journal reported 

that at least four Chinese teams are actively cloning human embryos as sources 

of stem cells. 

• Gene therapy: China will continue to build on its initial success with Gendicine 

in other cancers and genetic disorders. 

• Toxicity research and animal testing—a large portion of preclinical toxicology 

testing involves routine testing in lab animals. This work is resource intensive 

but requires technical expertise. With its highly trained but relatively cheap 

workforce, China could become a major hub in providing these services to 

biotech/pharma companies globally. 

124 

• Manufacturing—China already has significant expertise in the fermentationbased drug and product manufacture. It is one of the world’s largest producers 

of Vitamin C and A and also a major producer of penicillin and other antibiotics. China could easily extend this expertise to other biotech-based microbial 

and mammalian-cell culture. 

Government incentives and funding will continue to support and nurture the 

emerging biotechnology industry. China is in the process of making its biotechnology 

industry more broadly market friendly, though protectionism of domestic companies 

still exists. Starting in 2003, China has eased some of the geographic and capital 

restrictions on foreign companies to operate retail and wholesale pharmaceutical 

(companies still need local R&D/manufacturing investment to be able to participate 

directly in local currency sales without going through a local dealer). In addition, 

government support for biotech is changing from the current fund-oriented support 

for biotech research and associated industrialization to policy-oriented encouragement. The incentives planned include: 

• No ownership restrictions to be imposed on the enterprises engaged in biotech 

research and industrialization. 

• Biotech industries to be favored during IPO applications. 

• The venture capital invested in biotech industries to enjoy income tax exemption. 

• The biotech products of independent intellectual property rights to also enjoy 

tax holidays. 

The government is also increasing its support in several existing programs as well 

as providing strong encouragement for universities to start businesses. 

• In 2001, government announced that it plans to increase government funding 

of ag-biotech research by 2005 to $500 million annually (a 4–5X increase). 

• For 2001–2005, $240 million will be invested in nanotechnology R&D—funding 

to be provided by Ministry of Science & Technology, National Committee for Development & Planning, the Chinese Academy of Sciences, the National Natural 

Science Foundation of China, and the Ministry of Education. 

• Central government support to biotech as part of the 863 program is expected 

to more than double from the current $300 million annually to more than $600 

million by 2005. 

3) Assessment on what role foreign companies, investors, and scientists and 

engineers play in the sector. 

The unmet needs and immense growth opportunities of the Chinese healthcare 

market present a prime opportunity for foreign biotechnology/pharmaceutical companies and investors to tap into. Their ability to play in this market has been considerably eased by China’s admittance to the WTO. However, foreign companies, investors and governments can play a role by ensuring that they can help bring the 

best treatment options to the Chinese market, make a fair profit and preserve their 

intellectual property in doing so. By increasing the ability of the Chinese to meet 

their healthcare needs and their ability to participate in the global market through 

products developed in China, these external agents could provide the greatest incentive for China to become a full participant in the global biotechnology industry. 

As discussed above, one of the key issues perceived to be holding up the growth 

of the Chinese biotechnology industry is the lack of technologically savvy management. Foreign companies and investors can play a critical role in bringing in talent 

that has been trained in more developed biotechnology environments. It will also be 

instrumental in training local talent in management best practices. Foreign investment could have spin-off benefits in forcing a more thorough evaluation of company 

technologies and economic prospects, a broadening of potential markets for products, 

and most likely encourage more investment in biotech in local capital markets. 

Participation of foreign companies is also likely to improve the level of collaboration between Chinese biotech companies and those in more developed markets. This 

will have the effect of speeding products to market as well as improving their potential value once they are there. 

As has happened with semiconductors and other high tech markets, a greater foreign involvement in the Chinese market will also increase the level of services 

outsourced to Chinese industry—manufacturing, lab animal toxicology testing, etc. 

4) What domestic and international factors promote and constrain the development of biotech in China? 

Key factors that promote the development of biotech in China (most have been 

discussed above). 

125 

• Availability of research talent at globally competitive rates. 

• Government support, investment and incentives. 

• Strong R&D infrastructure. 

• Liberal approach to potentially thorny areas such as GMOs and stem cells. 

• A large population (1.3 billion) that is becoming more health conscious (i.e., increasing its awareness of chronic illnesses and lifestyle drugs in addition to infectious diseases) and has more disposable income to spend on medicine. 

Key factors constraining the development of biotech. 

• Lack of high caliber management talent that is also biotech savvy. 

• Lack of private investment in biotech. 

• Insufficient protection for IP. 

• Insufficient clarity of financial environment, legal infrastructure for contracts 

etc. 

• Weak regulatory, financial and legal infrastructure. 

• The ‘‘Guangxi’’ effect—who you know is often more important than the letter 

of the law. 

• Governmental price controls on healthcare products. 

• Relatively low purchasing power of the population. 

5) In particular, are any of these constraints created by inadequate intellectual property protection and market access limitations. 

China has recently taken several steps to revamp its legislative and regulatory 

environment to protect intellectual property. As part of its joining the WTO, it has 

made several specific reform commitments and is also a contracting party in the 

Patent Cooperation Treaty. Its patent statutes align well with international norms 

and its Intellectual property office is perceived to perform much better than its 

counterparts in other developing countries such as India and Brazil. 

Despite these advances, however, the US and other developed countries have a 

major role to play in encouraging China to adequately enforce intellectual property 

rights. The Biotechnology Industry Organization (BIO) has identified three major 

areas for improvement: 

1. China does not consider transgenic plants and animals eligible for protection. 

This denies adequate protection for the full range of assets of many biotech 

companies. 

2. The Chinese legal infrastructure is inadequate in supporting investigations of 

IP infringement activities and for enforcing judgments based on these infringements. BIO thus considers the effective level of IP protection for biotechnology 

to be inadequate. 

3. China’s laws also do not protect ‘‘essentially derived’’ varieties of plants, which 

constitute the vast majority of recombinant plant varieties (derived from registered plant varieties). 

China will have to further address these issues before foreign investors and companies become more comfortable with investing in that market. 

China is in the process of making its biotechnology industry more broadly market 

friendly, though protectionism of domestic companies still exists. Starting 2003, 

China will allow foreign companies to operate retail and wholesale pharmaceutical 

businesses with no geographical or capital restrictions. In addition, government support for biotech is changing from the current fund-oriented support for biotech research and associated industrialization to policy-oriented encouragement. The incentives planned include: 

• No ownership restrictions to be imposed on the enterprises engaged in biotech 

research and industrialization. 

• Biotech industries to be favored during IPO applications. 

• The venture capital invested in biotech industries to enjoy income tax exemption. 

• The biotech products of independent intellectual property rights to also enjoy 

tax holidays. 

However most foreign participants still face difficulties while going about doing 

business if they do not have the ‘‘right connections’’ or ‘‘Guangxi’’. The regulatory 

framework and enforcement continue to be relatively weak. For example, contract 

laws are often not enforced uniformly thus bringing mistrust into the business deals 

and undermining collaborations and partnerships. 

In addition, Chinese stock exchanges are perceived to be set up primarily to deal 

in shares of state-owned enterprises being privatized—no capital market exit strategy to motivate growth of venture capital. Plans are underway by government to 

create a stock market modeled after NASDAQ but status is uncertain. 

126 

6) Are Chinese firms and other organizations are investing overseas as a 

way of transferring technologies to China. 

There is little evidence of direct Chinese investment overseas in biotech companies. Chinese biotech/pharmaceutical companies tend to be very small (revenues of 

even the largest ones are under $1 billion). EBITDA margins and free cash flows 

also tend to be low as well. Hence, companies have little ‘‘currency’’ to make foreign 

acquisitions. Most of the large conglomerates in China are government-owned and 

do not yet have an M&A mindset. The fact that the Chinese currency is not yet freely traded also hampers the ability of Chinese firms to make foreign acquisitions. 

China, however, is actively recruiting expatriate scientists back to China by offering 

associate professorships and other incentives. Anecdotal reports indicate that it is 

having a lot of success in doing so. 

Also, there is increasing collaboration between Chinese scientists and their counterparts in more developed countries. Some examples cited by NES include: 

• Beijing Genomics Institute—collaborating with Syngenta (created by the merger 

of AstraZeneca’s and Novartis’ agrifood businesses) to sequence the genomes of 

a long-grain rice and a short-grain japonica rice variety. In April 2002, it published drafts of the genomes with the full sequencing expected in one or two 

years. UCDavis is using results to pin down genes in rice genome specifically 

targeted at resisting fungus. 

• Shanghai Institute of Entomology—collaborating with Entomed (Strasbourg, 

France biotech company) in search for novel insect-based drugs. 

• Chinese government seed company entered into a joint enterprise with Monsanto in 1996 to produce and market transgenic crops. The collaboration increased yields by 30% more than local varieties. 

• Beijing University—together with Yale University (US) formed the Peking-Yale 

Joint Center for Plant Molecular Genetics and Agro-Biotechnology. The multidisciplinary research program in plant biology had a specific emphasis on crop 

improvement. 

• Chinese Academy of Agricultural Sciences collaborating with Hong Kong Institute of Biotechnology to develop new varieties of Chinese vegetables and fruits. 

The Shanghai ‘‘Medical Valley’’ already has several top 20 global pharmaceutical 

companies with a local presence. There is also evidence of increasing investment by 

foreign pharma/biotech firms in China. For example, Roche recently announced that 

it will establish an R&D centre at Zhangjiang Hi-Tech Park in Shanghai, China. 

The centre will support the Roche Group’s worldwide R&D activities and its strategic business development efforts in the Chinese market. It is scheduled to be fully 

operational by the end of 2004, the Shanghai facility will initially be staffed by 40 

chemists. 

In closing, the large, increasingly health conscious and increasingly affluent Chinese population presents a significant opportunity for biotechnology and pharmaceutical companies that are looking for new avenues for growth. Governments of 

countries, in which these biotechnology and pharmaceutical companies are based, 

also stand to gain through increased tax revenues from companies’earnings in the 

Chinese market. In addition, China also provides a highly talented labor pool of 

dedicated scientists who could be leveraged to provide the burst of innovation and 

productivity that biotech and pharmaceutical companies in more developed countries are looking for. 

Co-Chair ELLSWORTH. Thank you, Mr. Lucier. 

Panel III: Discussion, Questions and Answers 

Co-Chair ELLSWORTH. Thank you all, panelists. I have been 

asked by several Commissioners to have the floor and ask you 

questions. Start off with Commissioner Becker. 

Commissioner BECKER. Thank you. 

First, Dr. Zhong, although I would appreciate it if each one of 

you would look at this a little closer and give me your opinion. 

First, some background information for me. The pool of pharmaceutical companies that you mentioned are determined to build a 

pharmaceutical industry in China. Are those Chinese companies or 

are they American or international companies that have relocated 

to China building these firms? 

127 

Dr. ZHONG. Okay. In China, in the pharmaceutical industries 

there’s domestic Chinese companies, as well as the foreign companies, yes. And so, the domestic companies has about, as I said, 

about 65 percent of the market share while the foreign companies 

have about 25 percent to 35 percent of the market share. Yes. 

Commissioner BECKER. Very good. The other question is equally 

as simple. Biomedical. I knew that the United States had agreed 

that pre-clinical testing could be done in China. But now I understand from the testimony here today that clinical testing is also 

being done? 

Dr. DANCE. Clinical testing is being done. In the start-up companies, for instance, the only firm I’m aware of is a smaller biotech 

company in San Diego that did do its Phase 2 trials in China. 

There are issues—you cannot at present do all your final trials 

in China and get it approved. But you can do trials in China and 

get the human data accepted. You still have to do a U.S. trial before final approval. 

Commissioner BECKER. This is a question for all of you. 

Are you satisfied that the data you receive back here in the 

United States from pre-clinical testing and clinical testing as accurate and as reliable as if you had run the test here in the United 

States? 

Dr. DANCE. If the company— 

Commissioner BECKER. Are you comfortable with this? 

Dr. DANCE. If the company running the trials correctly monitors 

what’s going on, all the Tier 2—so-called Tier 2 countries, whether 

it’s in Peru or it’s in India, for instance, is way ahead of China in 

trying to get trials done. Yes. You can get very reliable data, but 

you have to very closely monitor it with your own people. 

Commissioner BECKER. I raise this because the standards we 

have here in the United States and the procedures that we follow 

for clinical testing and pre-clinical testing reminds me of the problem we ran into back in the ’50s and the horrible experience we 

had with thalidomide. Coming out of that established very rigid 

standards in the United States on biomedical. I think we need to 

be absolutely sure that the Chinese are meeting those same rigid 

standards and that we can take that to the bank so we don’t suffer 

some kind of a catastrophe. 

Dr. DANCE. Again, if it’s a U.S. company running trials in China, 

you can be assured that all the protocols and so forth are forced 

into the system. And they’re known worldwide now. And they have 

their internal review boards. They have all the structures. 

If it’s just a Chinese company running the trials themselves, 

then they have data, and there’s a lot of that so-called anecdotal 

data and so forth. It’s interesting, but it’s not accepted. 

Commissioner BECKER. Well, it seems like to me that through 

globalization in other countries, whether it be Mexico or whether 

it be China, mistakes happen. 

We have the SARS epidemic, and the fact that this was not reported and it took World Health Organization to push this before 

we could get the Chinese government to own up to the fact of the 

seriousness of it. And we have the bird flu. And from Mexico we 

had the—I want to say herpes 3, but I don’t know what it was exVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00133 Fmt 6633 Sfmt 6602 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
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actly now, that came in through onions and killed people in Pennsylvania— 

Dr. ZHONG. Hepatitis. 

Commissioner BECKER. —and hospitalized much more of them. 

I’m just saying our standards have come about through trial and 

practice. And for us to turn that very important pre-clinical and 

clinical testing over to another country just because they do it 

much cheaper— 

Mr. LUCIER. I think, Commissioner, what you’re going to see is 

something a little different. 

We just purchased the largest preclinical biological testing company, and we’re now the largest pre-clinical company in the world. 

I don’t know a lot about it yet, but I will tell you what will probably happen is that companies like mine will move their operations 

into China following the same U.S. standards that you are advocating, but do it on Chinese soil because it is substantially less expensive. 

Mr. PANETTA. Commissioner, I would add to that, that because 

of the fact that the biotechnology industry doesn’t have still the 

depth of experience in moving products through the FDA approval 

process, the tendency in biotechnology is still to be cautious about 

ensuring that the data that are submitted are of the highest standards, the highest integrity and that we can continue to build a reputation with the FDA. 

And one of our greatest challenges in moving products into commercialization is the fact that, for the most part, biotechnology 

doesn’t have the experience with the regulatory process here in the 

United States. 

And when I say experience, I’m talking also about the personnel 

within biotechnology companies who haven’t developed that lack 

of—that depth of experience yet. That there’s a tendency still on 

the part of the industry to ensure that we do everything possible 

to build that reputation using the high standards that have been 

set by the FDA for product approval. 

Co-Chair ELLSWORTH. Thank you, Commissioner Becker. 

Thank you, Panel. 

I want to remind my colleagues among the Commissioners and 

also the panel that we are behind schedule, and we’re trying to not 

cut off discussion and dialogue, but we’re trying to catch up if we 

can. 

Commissioner Wortzel. 

Commissioner WORTZEL. Thank you. This may surprise some of 

you, but during the time that I worked in China with the American 

Embassy, we actually spent a good bit of time looking at what 

seemed to be a fairly well developed biological defensive and offensive warfare infrastructure within the People’s Liberation Army. 

And I don’t think we’ve ever completely resolved our concerns 

about offense versus defense. Defense is fine. So Question number 

one is, can you tell me what you’re doing in terms of due diligence 

to ensure that any Chinese partners or either technology or intellectual property that you’re bringing in there doesn’t end up inside 

the People’s Liberation Army and used for those purposes. 

129 

The second thing—it might surprise you—is there’s sort of a 

large authoritarian infrastructure in China. And all human testing 

was not necessarily informed testing with informed consent. 

So how do you know and how does the American public know 

that there aren’t a whole bunch of people that are sort of compelled 

laboratory rats, which we wouldn’t do in the United States? 

And the third question I have specifically concerns 

nanotechnology because that is an area of great interest, I would 

say, to the U.S. military and the intelligence community because 

of its potential for different forms of weaponry, including space 

weaponry that China’s working on, and for intelligence surveillance 

and reconnaissance. 

So, first, is any of the nanotechnology that you’re working on of 

dual use in nature? Does it need a commodities control list export 

license or an arms export control list license to get out? And, second, how do you know who you’re working with there? 

Dr. ZHONG. Okay. I would like to answer the second question 

raised by Commissioner Wortzel and which is also connected with 

Commissioner Becker’s questions. 

In China the pharmaceutical industry established the GMP, the 

so-called good manufacturer practice compliance system right now. 

And a lot of these GMP is—the standard is established by the 

international pharmaceutical industry. It’s an international standard. And lots of the factories of China, the GMP has to be audited 

by the USFDA. And the same thing also established in China is 

the good laboratory practice, the so-called GLP. And it’s the same 

thing in the clinical trial. Now, for clinical trial, if—eventually if 

the FDA will allow China’s data to be transferred to the United 

States, I think FDA will definitely do an audit and issue a license 

for—you know, to make sure the quality is there. So I think this 

definitely will help to solve the concerns that a lot of Americans 

have about the Chinese data and things like that. 

Commissioner WORTZEL. Well, we transferred German and Japanese warfare experimental data to the United States too, but it 

doesn’t say anything about the ethics under which the data were 

gathered. 

Dr. ZHONG. Right. I understand your concern. Yes. 

Dr. DANCE. Again, trials, and—first of all, biotech, as was mentioned, is not big. The Big Pharma companies, the Lillys and so 

forth, you know, are much more in the forefront. But when San 

Diego or other biotech companies are doing trials there, the only 

way they’re going to be of use is if they’re effectively run by the 

company here. And all the structures for reviewing for safety of patients, making sure each patient is talked to and understands 

what’s happening and so forth are part of any trial. Now, that 

doesn’t mean that trials by other companies going on; but U.S. 

companies doing trials in China are done under all the rules and 

regulations that would happen here. 

Co-Chair ELLSWORTH. Thank you. 

Commissioner WORTZEL. Any takers on nanotechnology? 

Mr. LUCIER. The nanotechnology industry is obviously very nascent. We’ve developed a number of microspheres, nano-particles 

that can tag molecules and things of that nature. What we see, 

though, is that the research being done on those types of tools is 

130 

primarily centered in the United States. Again, the research we do 

in the United States is, I would say, one to two times more advanced than what’s taking place today in China. So we haven’t exported anything of that nature yet. 

Co-Chair ELLSWORTH. Thank you, Commissioner. 

Thank you, Panel. 

Commissioner Mulloy. 

Commissioner MULLOY. Thank you. I was looking at Dr. Zhong’s 

testimony. And he tells us that—on his testimony, page 8—the Chinese government appears to be determined to build the country 

into a major player in the pharmaceutical industry. 

And, Mr. Lucier, you tell us that Chinese—on page 3 of your testimony, the Chinese government actively supports the biotechnology industry as part of its high-technology program. And 

then you further tell us that they’re offering—for people who have 

Ph.D.s that come here to study, they want to bring those folks back 

to China and that they’re offering them associate professorships. 

As a result, China’s very quickly building a very talented pool of 

people who are very good in this. 

And, Dr. Zhong, you make the same point. And you tell us that 

they can do this work at one-tenth the price that people in the 

United States can do it. 

So the question I have, is there anything inherently different— 

you know, the whole consumer electronics industry has moved out 

of this country. 

Now, is there something inherently different in the pharmaceutical industry that makes it not subject to these tendencies to 

move, or could a government with a clear national strategy that 

they want this industry to accomplish the same thing in this industry as has been accomplished in some other industries? 

And I would really like the panel—and one last thing I noted, Dr. 

Dance. Is it the Chinese government investing in your fund, or who 

is investing in this fund? 

Dr. DANCE. It’s a Chinese individual. Now, the wealthy Chinese 

individuals all have government connections, but it is not a government investment. 

Commissioner MULLOY. Okay. So by investing in your fund, 

you’re at least identifying those technologies at an early stage, 

which are going to pay big, maybe big dividends. So is there anything inherently different in your industry that can prevent this 

thing from happening to you that’s happened to other major industries in this country in terms of just being outsourced to another 

country? 

Dr. ZHONG. Yes. I think the move on the activities from the 

United States to China will be somehow limited. And the thing— 

the major thing is that the U.S., especially the biotech company industry, is looted from universities and the research institutes. 

And at the R&D level these companies have very, very tight relationships with the U.S. universities and the research institutes. So 

I think that most of the research and the development activity will 

be still remaining in the United States. 

Commissioner MULLOY. What do you think, Mr. Lucier? 

Mr. LUCIER. Perhaps I would give a little bit more mixed answer 

to that, which is that the United States has an incredible research 

131 

heritage by funding the universities and the National Institutes of 

Health. And to the extent we continue these efforts, which happened very nicely over the last several years, our position as a preeminent biotech country is assured. However, when you look at 

more recent Federal budgets the investment in government-funded 

research is now is trailing off. This should be of concern for those 

who are focused on making sure the USA stays strong in biotech. 

Now, having said that, there is the countervailing trend that still 

says as these other countries, like India and China, come up, there 

is nothing to say that their industry isn’t going to grow probably 

faster on a relative basis than the United States. The key, really, 

is for the United States to remain in a leadership position. And we 

have to continue to fund the NIH, and the universities to the extent we have historically; otherwise, you will lose this industry. 

Commissioner MULLOY. In other words, you’re telling us the government does have some role in helping the United States to maintain its— 

Mr. LUCIER. I would say in this industry, the government has a 

massive role to maintain an edge in biotech. 

When I look at our business, it all emanates out of governmentfunded research, and it all finds its way eventually towards commercial property. 

Commissioner MULLOY. Thank you very much. That’s very helpful. 

Co-Chair ELLSWORTH. Thank you, Commissioner. 

Thank you, Panel. 

Commissioner Dreyer, please. 

Commissioner DREYER. One quick question and then one longer 

one. 

I was fascinated to learn about China’s work on genetically modified organisms. And one of the reasons is that China has been objecting to importing U.S. soybeans and so on is because they are 

genetically modified organisms. Do you see some kind of contradiction, as Mao Zedong might have said, in this? That’s the quick 

question. 

The other one is, a couple of years ago I listened to a speech by 

Annette Lu, the president of Taiwan, talking about how Taiwan’s 

economy could continue to grow and prosper only if Taiwan remained on the cutting edge of technology. Biotechnology was the 

area she advocated for Taiwan to do this next in. That set me wondering, has it happened? And if so, has it done so in competition 

with the mainland or in cooperation with the mainland? I believe 

Mr. Lucier mentioned that there was Taiwanese capital involved, 

but I’m thinking of joint research projects or something like that. 

So that’s my longer question. 

Mr. PANETTA. Maybe I could take the first one because I worked 

in this field for about 15 years before coming into my current position, Commissioner. 

I think in my experience the issue of whether or not a country 

will accept genetically modified organisms doesn’t go so much to 

the issue of whether they’re safe or whether there are processes 

available to evaluate the safety and the risk of genetically modified 

organisms because those exist. 

132 

Now, we set the standard here in the United States. There are 

processes in Europe and other parts of the world to adequately 

evaluate safety and risk. 

It comes down to more protectionism than anything else, and 

that protectionism goes to countries, not just China, wanting to 

catch up. And they’re buying time by taking this kind of approach 

until they’re to a point where they have the same ability. 

Because there’s no question that this technology is going to 

project agriculture to a level where we are going to be able to feed 

the population of the world as it grows and doubles. But that’s my 

take on it. 

Commissioner DREYER. Thank you. And do I have any takers for 

the second part? 

Mr. LUCIER. I’m not sure about the Taiwanese investment. I 

think one of my other colleagues talked about that. 

However, the Taiwanese biotech industry is very strong. On a 

relative basis, though, we see a lot more investment now going into 

China and research projects in Mainland China than Taiwan. 

So—— 

Commissioner DREYER. I’m sorry. Who is doing the investing? 

Mr. LUCIER. Both commercial companies in Taiwan and the government. In Mainland China it’s primarily the government investing into this industry for research purposes. So to give you relative 

growth rates that we see in our own business, Taiwan over the last 

five years was probably growing at a 25 percent annual clip. It has 

slowed down now. Mainland China is growing at upwards of 25 to 

30 percent now, at least in our business. So we see a shifting taking place towards Mainland China. 

Commissioner DREYER. Anyone else? Thank you. 

Co-Chair ELLSWORTH. Thank you, Commissioner Dreyer. 

Thank you, Panel. 

Commissioner D’Amato, please. 

Vice Chairman D’AMATO. Thank you, Mr. Chairman. Mr. Lucier, 

do you find in your experience in the China market—I want to get 

a little idea of what you experience. 

In order for you to operate in the Chinese market, is it necessary 

for you to take on Chinese partners or Chinese investment or Chinese piece of your action by the government or other commercial 

firms. 

Mr. LUCIER. Under the current trade regulations—and I’m not an 

expert here, but I understand there’s really two vehicles, and I’ll 

tell you the one we’re pursuing. Today we go to market primarily 

through distributors. However, this year that will change, and we’ll 

either acquire a company so that we will have full-time presence 

in China. Or, as I understand it, you can joint venture in through 

a trading relationship with a local company and then assume full 

ownership after 2006, I believe. 

So, one of those two vehicles for us will be the way that we continue to expand our business beyond just being a distributor of 

these products that we do today. 

Vice Chairman D’AMATO. So you have to either acquire a company—and does that company then become part owner? 

Mr. LUCIER. No. It becomes a fully owned subsidiary of 

Invitrogen then. And it’s part of an American corporation. 

133 

Vice Chairman D’AMATO. Okay. Now, in terms of enforcement 

penalties, IPR, how big a problem is the IPR piracy issue that you 

experience? Do you experience that? 

Mr. LUCIER. We really don’t experience too much in terms of piracy of our intellectual property. I’m not so sure that our products 

are worthy of piracy. They’re smaller. They’re more just enabling 

technologies to allow you to do bigger things in research. And so 

we haven’t seen a lot of that take place in both India or in China, 

quite frankly. 

Vice Chairman D’AMATO. Maybe that’s a better question for Mr. 

Panetta’s companies. What kind of a problem is piracy for your association? 

Mr. PANETTA. I think, Commissioner, it comes down to the fact 

that we don’t have that much experience with biotechnology therapeutics and other products being marketed in China yet. And the 

concern is—I think it’s one of apprehension more than anything 

else. Before entering China with these products, my members want 

to be darn sure that they’re going to receive the protection and the 

enforcement of their intellectual property because they can lose it 

in an instant without that protection. So the greater assurances of 

that protection would encourage greater movement into China. 

Vice Chairman D’AMATO. Do you get assurance that they’ll be 

protected from the government? 

Mr. PANETTA. We’re receiving those assurances. As Dr. Zhong 

mentioned, things are changing in China, and those assurances are 

being given. 

And that’s, I think, creating more interest in opportunity in 

China. It’s a matter of who’s going to step into the pool first. 

Vice Chairman D’AMATO. Yes. Because across the board, the 

problem is that there is no enforcement of the IPR laws. They put 

the laws on the books, and they don’t enforce them. But that’s not 

something that you experience yet as a big problem for your industry? 

Mr. PANETTA. No. 

Vice Chairman D’AMATO. Okay. Thank you. 

Co-Chair ELLSWORTH. Thank you, Commissioner D’Amato. 

And thank you, Panel. 

Well, this panel has come to an end. It’s interesting that the next 

panel is going to take us slidingly and gracefully, I hope, into some 

of the same issues we’ve just been discussing: China as a HighTech Leader: Technological Capabilities: Intellectual Property Protection and Market Access and Chinese Overseas Investment. 

And we’ll resume with that panel after a very brief, very brief 

five-minute break. So thank you very much. 

(Recess taken from 2:26 p.m. to 2:33 p.m.) 

PANEL IV: CHINA AS A HIGH-TECH LEADER: TECHNOLOGICAL 

CAPABILITIES: INTELLECTUAL PROPERTY PROTECTION 

AND MARKET ACCESS AND CHINESE OVERSEAS INVESTMENT 

Co-Chair ELLSWORTH. Thank you very much, ladies and gentlemen. Panel IV, seated before us, has as its subject China as a 

High-Tech Leader: Technological Capabilities: Intellectual Property 

Protection and Market Access and Chinese Overseas Investment. 

134 

And to take us through that very rich topic we have William 

Bold, Vice President, Government Affairs, QUALCOMM; Jason 

Dedrick, Center for Research on Information Technology and Organization, University of California, Irvine; Dr. Francine Berman, Director of the Supercomputer Center, University of California, San 

Diego; and Dr. Michael May, Professor Emeritus, Center for International Security and Arms Control, Stanford University. Dr. May, 

in an earlier incarnation, was director of the Lawrence Livermore 

National Laboratory. 

I’ll start with Mr. Bold, and we’ll go down the panel in that direction, if you please, with five minutes to begin, and then for the 

Q and A, seven or eight minutes for each Q and A—or is it the reverse? The reverse. Seven or eight minutes for your opening, and 

then five minutes for the Q and A. 

Please, Mr. Bold. 

STATEMENT OF WILLIAM BOLD, VICE PRESIDENT 

GOVERNMENT AFFAIRS, QUALCOMM, INC. (TELECOMMUNICATIONS) 

Mr. BOLD. Thank you, Mr. Chairman, members of the Commission. 

My name is William Bold. I’m vice president of Government Affairs for QUALCOMM Incorporated, the largest private company in 

San Diego. In this capacity I manage QUALCOMM’s relationships 

with governments, not only here in the United States, but around 

the world and have been closely involved with our dealings with 

the Chinese government. 

QUALCOMM is a leader in developing and delivering innovative 

digital wireless communications products and services based on the 

company’s Code Division Multiple Access technology known 

colloquially as CDMA. CDMA technology has become the leading 

choice for what is called third-generation wireless communications, 

which combine both voice communications, traditional and cellular 

systems, with high-speed wireless Internet access of up to 2.4 

megabits of data per second. So very fast. Today there are more 

than 60 million subscribers to this 3G CDMA technology in more 

than 30 countries, including China and the United States. 

We derive most of our revenues from two activities: The design 

and sale of ASIX, or semiconductors, which are used in mobile 

phones and network equipment, and the licensing of our considerable portfolio of intellectual property. QUALCOMM licenses this 

portfolio to vendors, who then in turn develop phones, network 

equipment. So we’re not involved in the manufacture of products, 

but, rather, we enable companies to manufacture their own products for sale. 

As of September of last year we have been issued more than 

1,000 patents for our technologies, primarily focused on CDMA. 

And we’ve consummated royalty-bearing licenses with some 115 

companies, including basically every major equipment vendor in 

the wireless communications industry. 

China has been a very important market for QUALCOMM. Since 

2001 the growth of mobile phone subscribers in China has increased by, on average, 4 million subscribers on a monthly basis. 

The total number of mobile phone subscribers is now over 200 million, and the market is expected to continue to grow at a fairly 

135 

rapid clip. Our experience, though, in introducing CDMA technology to China was a long one. We worked for more than a decade 

to educate Chinese officials and Chinese companies on the value 

and proposition of CDMA as a platform for supporting, again, not 

only voice, but data services. After some fairly intense business and 

political diplomacy, the Chinese government did agree in 1999 to 

license CHINA UNICOM, which at that time was the second-largest wireless operator in China, to operate a nationwide network 

based on CDMA technology. 

The network became fully operational in 2002 and today we’re 

happy to say boasts more than 20 million subscribers. 

As part of the process of introducing our technology to China, 

QUALCOMM negotiated licensing agreements with prospective 

Chinese equipment vendors. And these vendors, the Chinese government and QUALCOMM itself regarded the extension of these licenses as an opportunity to strengthen what has become a growing 

competency in China in the design and manufacture of wireless 

equipment at very sophisticated levels. This is something we’ve 

done in previous markets, like Korea and Japan, where we’ve introduced CDMA in companies such as Samsung, Kyocera, Hyundai, 

today make some of the most innovative phones available not only 

in those markets, but here in the United States. In most global 

markets we negotiate our licenses on a bilateral basis, business to 

business. 

In China we took the rather unorthodox step of negotiating what 

was called a framework agreement; not with the government and 

not with the vendors themselves, but, rather, with the network operator, CHINA UNICOM. That framework agreement then gave us 

the basis to go to the individual equipment vendors and negotiate 

royalty-bearing licenses. And this process, while unorthodox, certainly resulted in a satisfactory result for QUALCOMM and I think 

for American industry generally. 

Under the framework agreement, QUALCOMM granted these 

royalty-bearing licenses to Chinese vendors in exchange for a commitment that they would purchase QUALCOMM semiconductors so 

long as those semiconductors were competitive in terms of both 

price and function. 

Subsequent to the negotiation of that agreement, the Chinese 

vendors have, indeed, stepped up their efforts and developed some 

very innovative phones and network equipment that are being sold 

not only in their domestic markets, but also significantly, I think, 

in export markets, particularly in the developing world. One issue 

that has come to the forefront in our sector is Chinese efforts to 

develop technical standards. And this is something that I think has 

probably been touched on in previous panels. But it’s probably been 

most prominent in our sector where Chinese academia and industry have brought forth a standard, which is known by the acronym 

TD-SCDMA. It’s actually a variant of the CDMA technology, which 

QUALCOMM originally brought to the market, but it’s been 

tweaked a little bit by some Chinese vendors and by Siemens, the 

large German telecommunications manufacturer. It’s based on our 

technology, and we are indeed supporting it. 

As Chinese vendors extend their participation in both domestic 

and foreign markets, we think that they will naturally seek to deVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00141 Fmt 6633 Sfmt 6602 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
136 

velop IPRs and patent those IPRs and hopefully export them into 

third markets. We view this development, frankly, as very positive. 

As a company whose lifeblood is the licensing of IPR, we believe 

that a Chinese IPR industry will hopefully provide new perspectives to the Chinese government and the companies themselves on 

the importance of adherence to the WTO agreements that are relative—relevant, rather, on TRIPS and other areas. Looking forward, we see two major issues facing us in China. The first is the 

potential of wireless communications to transform Chinese business and Chinese society. 

Wireless communications are cost-effective relative to fixed line, 

copper or fiberoptic communications. 

So we expect that our partners, CHINA UNICOM and future 

Chinese operators, will be able to offer many Chinese consumers 

their first Internet access on a wireless device. This is particularly 

true in western China. With burgeoning population, but very, very 

poor telecommunications infrastructure, very low tele-density relative to the eastern regions of China. 

Our technology, which as I mentioned before, can offer data rates 

of up to 2.4 megabits per second would be ideal to serve this market for at least a couple of reasons. First, the phones and the 

equipment, the portable devices are very cost-effective relative to 

desktop computers or even laptop computers. Secondly, the technology that we’ve developed can be deployed by operators in China 

without the need for them to go obtain new spectrum. 

This is actually similar to what Verizon Wireless is doing here 

in the United States where they’re offering this very fast wireless 

communications technology without a grant of new spectrum from 

the Federal Communications Commission. 

The same situation is true in China. And in a time with fairly 

scarce resources, we think that this will set China ahead. The 

other main issue, though, does involve spectrum allocation. The 

Chinese government is currently considering the terms of future licenses for both their existing and their new wireless operators. 

We have encouraged the ministry of information industry, which 

governs this process, to license operators on a technology neutral 

basis, as we encourage governments around the world. 

We actually are fairly confident that the Chinese do understand 

their obligations under the WTO and the advantages of letting the 

market decide to an extent which services are most attractive. 

So in conclusion, we continue to believe that the Chinese wireless 

market offers unique opportunities to companies such as 

QUALCOMM. Our experience to date has been different than in 

other markets, but it certainly has been positive. And while we’ve 

yet to consummate a number of licensing agreements with certain 

Chinese vendors, we do believe that this process should go smoothly in accordance with international and domestic laws. 

We believe wireless communications will help transform Chinese 

society and business, and we look forward to a very productive future in what is one of our most exciting markets. Thank you. 

Co-Chair ELLSWORTH. Thank you, Mr. Bold. 

Mr. Dedrick, if you will, please. 

137 

STATEMENT OF JASON DEDRICK 

CENTER FOR RESEARCH ON INFORMATION TECHNOLOGY 

AND ORGANIZATION 

UNIVERSITY OF CALIFORNIA, IRVINE (ELECTRONICS 

MANUFACTURING) 

Mr. DEDRICK. Yes. Thank you, Mr. Chairman and Commissioners. 

I have been doing research on the computer industry in Asia for 

about the past ten years. And my colleague at UC Irvine, Professor 

Ken Kraemer and I have written a book and some papers on the 

industry. And one of the main questions we’ve asked is, has Asia’s 

incredible success in computers been good for the U.S. or not? Our 

conclusion when we wrote our book about five years ago is that on 

balance, it was beneficial to the U.S. computer industry and even 

to U.S. workers. And this was for three reasons. 

One was, by developing production networks in Asia, U.S. companies were able to compete with the Japanese who at one time were 

predicted by almost everyone as being ready to take over the computer industry from the U.S. Secondly, U.S. companies were able 

to pass off low-value, low-margin manufacturing to Asia and keep 

the increasing returns or higher profit and higher margin industries in the U.S. 

As more than one Taiwanese company said to us while we were 

doing research, we’re all killing ourselves to make money for Microsoft and Intel. 

Commissioner DREYER. I’m sorry. We’re all killing ourselves to 

make money from what? 

Mr. DEDRICK. Make money for Microsoft and Intel. 

So those are American companies. And, third, I think maybe 

most importantly, the fact that we had access to cheap hardware 

or lower cost hardware from Asia meant that, for one thing, the 

I.T.-driven productivity boom of the late ’90s was made possible. 

And, secondly, while there was a net loss of jobs in hardware production in the U.S.—and I don’t mean to minimize that based on 

the discussion we had this morning. A lot of people at IBM and 

DEC and places like that lost their jobs, but there were many more 

jobs created in the U.S. software and I.T. services industry than 

were lost in hardware. So while there were adjustments and there 

were losses, on balance we felt that the impact of the growth of 

Asia was good for the U.S. industry and for the U.S. 

Now, since that time the big phenomenon in Asia has been 

China. China has gone from $1 billion in computer production to 

$45 billion in a decade; is now the second-largest computer producer in the world, having passed Japan, and probably will pass 

the U.S. before long. It’s also become the second-largest PC market 

in the world. The overall I.T. market is still not one of the largest, 

but it has passed Japan as the second-largest PC market. Some of 

the numbers that people brought up this morning I think also 

helped make that point of how rapid the ascension of China in the 

computer industry has been. Has this been good for the U.S. or 

not? This is a question I think we need to revisit. And this leads 

to a couple of the questions that are the theme of this panel. One 

is intellectual property. Another is market access. 

Besides that, I would add the question of competition, whether 

U.S. companies are creating their own competitors. I think the 

138 

things that made the situation of the ’90s with the Taiwanese suppliers work out so well for the U.S. is that the Taiwanese never 

really tried to compete with the U.S. PC companies. They were 

happy to be suppliers, and they didn’t really have the resources to 

tap global markets. So one question we might raise is whether this 

is going to be the case in China or whether Chinese companies will 

end up being global competitors to the U.S. Second question is 

whether U.S. companies will be able to compete in this growing 

Chinese market. If it’s now the second-largest PC market and it is 

by far the fastest growing—it’s also a fast-growing market for 

many other IT products—what kind of success are American companies likely to have there? 

And, thirdly, of course, intellectual property protection. This is 

certainly already a big issue in the software industry. Microsoft has 

and the business software alliance have complained about the loss 

of revenue that they have in China due to piracy. 

Even the lawsuit that Cisco had against Huawei was a software 

issue. It wasn’t a hardware licensing issue. It was Cisco’s Internet 

operating system. 

So that issue, I think, is very important and one that we have 

to consider. And, finally, a new one that we’re looking at is the 

question of whether what we call knowledge work—software, design, engineering and so on—is going to follow manufacturing to 

China. 

And let me just address each of these very quickly and spend 

maybe a minute on each one of them. 

In terms of market access, can U.S. companies compete in China? 

There’s no real formal trade barriers anymore; however, most people do agree that China still favors local companies in government 

procurement. More importantly, though, is the distribution channels. Legend Computer now has about 30 percent of the China PC 

market, and the main reason for that is the distribution network 

that they’ve created, franchised resellers and also franchised distributors all over the country. Not just in the rich or coastal cities, 

but they blanket the whole country. This is something that would 

be very difficult for any foreign company to try to replicate at this 

point. It would be very costly. And in China you don’t have sort of 

a Comp USA or a Circuit City or a Best Buy that’s all over the 

country to give you distribution. Meanwhile, Dell has been in 

China trying to do their direct sales model, which is dominating 

the U.S. market. So far it’s had limited success because of the lack 

of physical, financial, legal infrastructure, credit cards, things like 

that. 

What I think you may see in the future is a situation like we 

have in Japan, where foreign companies and U.S. companies are 

able to fight over 20 or 30 percent of the market, but are not likely 

to become the dominant players. On the other hand, if you’re Intel, 

a good California company—they all have Intel chips in them, so 

it’s all good for them. So still everybody is making money for them, 

if not necessarily Microsoft. 

Will Chinese companies compete with U.S. companies in global 

markets? I would say not in the near future. They lack the branding. They lack the marketing, the distribution. A lot of capabilities 

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kets. A lot of other companies have tried it, including the Japanese, 

and haven’t been very successful in the computer industry. Plus 

they have a big market to grow in China. It’s a lot easier for Legend to grow in China with that market than to try to compete in 

the U.S. or other markets. On the long run this may be different. 

Legend has changed its brand name to Lenovo, specifically to be 

able to go into foreign markets with a brand name that’s not a generic name. Huawei is winning business abroad in network equipment, has a billion dollars in international sales. And now Haier, 

and appliance manufacturer which is pretty well established in the 

U.S., is moving into some electronics products. 

Finally, will knowledge work, such as design, development and 

engineering, follow manufacturing to China? It’s already happening. U.S. companies have outsourced most of their design, for 

instance, for notebook computers to Taiwanese suppliers. The Taiwanese are gradually starting to move that engineering, at the low 

end anyway, to China. And people in Taiwan are predicting that 

within a few years, the majority of that work will be done in China. 

On the other hand, the work that’s currently done in the U.S. of 

concept, preconcept design, industrial engineering, industrial design—will probably stay here because of the skills, the market access, the knowledge of the U.S. market that is important to that 

kind of work. 

A couple of final points. 

As Barry Naughton brought up this morning and other people 

did, this is not a U.S.-China story. It’s a U.S.-Taiwan-China story 

when you talk about the computer industry. And, also, I think it’s 

important to realize that things are changing very fast. What we 

were finding four or five years ago is not necessarily the case 

today. And I think some of the things that seem to be true now 

may not be true in a few years. 

So the situation is flexible and fluid, and what you think you 

know today may not be true tomorrow. 

Co-Chair ELLSWORTH. Thank you so much, Mr. Dedrick. 

Dr. Francine Berman, if you will, please. 

STATEMENT OF FRANCINE BERMAN, Ph.D. 

DIRECTOR, SUPERCOMPUTER CENTER 

UNIVERSITY OF CALIFORNIA, SAN DIEGO 

Dr. BERMAN. Thank you very much. My name is Francine Berman. I’m the director of the San Diego Supercomputer Center. I’m 

also a professor of computer science at UCSD. I’m very pleased to 

testify today before the Commission on developments in supercomputing and science. Understanding today’s integrated and global 

approach to technology and science has important implications in 

U.S. technology policy towards China. 

Today I’ll focus my remarks in three different areas. First, I’ll describe today’s global environment for supercomputing and science 

to give some context. Second, I’ll describe current trends in supercomputing in China. Third, I’ll discuss key characteristics for leadership in supercomputing and how it affects all of us. 

To start with, supercomputing is best defined as the highest performing technology that can be brought to bear on an individual 

problem. To date, supercomputing technologies have been widely 

acknowledged as an enabler for new generations of scientific disVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00145 Fmt 6633 Sfmt 6602 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
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coveries. Today supercomputing is accomplished by more than just 

high-performance supercomputers. Modern supercomputing applications utilize high-performance computers, high-speed networks, 

large-scale data storage, scientific instruments and other resources 

often coordinated by Grid and other integrated technologies to enable break-through scientific results. For example, consider the 

Human Genome Project: a combination of special-purpose machines 

for high-throughput DNA sequencing, large-scale data storage and 

high-performance computers were used to calculate 500 million trillion base-to-base comparisons to perform arguably the largest biology calculation to date. 

Leadership in high-performance supercomputing today is typically ranked, at least with respect to single machines, by ones 

ranked on the global Top 500 list. Of the world’s fastest 15 machines (measured in terms of speed when executing the solution of 

a dense system of linear equations on a dedicated machine), China’s submission is No. 14, preceded by 13 U.S. and Japanese supercomputers, with the top spot occupied by the Japanese Earth Simulator. Probably the largest commonality between the machines at 

the top of the Top 500 list is the considerable commitment, planning and funding over a substantial period required to develop and 

support the human, software, and hardware infrastructure required for a leadership position. 

Concurrent with the increasing integration and globalization of 

technology, science today has become a team sport. Many scientific 

disciplines are coming together, crossing national boundaries in unprecedented ways enabled by globally integrated technologies. 

For example, in High Energy Physics, scientists from around the 

world are coming together in the Compact Muon Solenoid project, 

or CMS, forming one of the largest scientific collaborations in history. The CMS experiments will allow scientists to recreate the 

conditions prevalent in the universe just 10 to 12 seconds after the 

Big Bang. As of mid 2003, 2300 people from 159 institutes in 36 

countries spanning Europe, Americas, Asia and Australia were involved in CMS. In short, today’s science and technology landscape 

provide an integrated and global perspective and tremendous potential for advances in discoveries, but not well represented by traditional notions of ownership credit, et cetera. It’s within this landscape that I would like to talk about China’s evolving science and 

technology programs. 

I’ll turn my remarks to China’s presence in supercomputing now. 

Over the last ten years, China’s rate of growth in supercomputing has been rapid. Today China has several supercomputer 

centers, the largest of which is CNIS, the Computer Network Information Center at the Chinese Academy of Sciences, which currently has a staff of about 170. 

In contrast, the National Science Foundation Supercomputer 

Centers here in San Diego and in Champaign-Urbana and in Pittsburgh, SDSC and NCSA have about 400 staff; and PSC has about 

90 staff. To date, China has the domestic capability to build fast 

supercomputers. Its current most powerful supercomputer is a Chinese-built commodity cluster model and is ranked 14th on the Top 

500 list. The U.S. and Japan, as I said before, have the preceding 

141 

13 computers. The Chinese have 9 supercomputers on the Top 500 

list, with the fastest after No. 14 being No. 82. 

The top 500 Chinese supercomputers are built by a variety of 

companies including Legend from China, IBM, HP and a homegrown computer at Shenzhen University. 

China’s first appearance on the Top 500 list was in 1995 with an 

IBM computer at the China Meteorological Administration, ranked 

143. It wasn’t until 2002 that the Chinese had a computer ranked 

higher, No. 43 at the Chinese Academy of Mathematics and Systems Science. In addition to high-performance supercomputers, 

China is also moving into the area of Grid Computing. With the 

U.S. and others, China is a founding member of the Pacific Rim 

Applications and Grid Middleware Assembly, or PRAGMA. 

PRAGMA is a highly successful international Grid project. 

China is also developing its own national Grid projects, including 

the China National Grid Consortium and the China Grid Forum. 

China also participates in a number of international networking 

projects, including the GLORIAD project linking the U.S., Russia 

and China, the Asia-Pacific Advanced Network, the Asia-Pacific 

Grid, et cetera. 

Technology is receiving a big push in China, as it is all over in 

the world, by access to and availability of information through the 

Internet. In 2003 China’s Internet usage rose 34.5 percent to 79.5 

million Web users, exceeding Japan for the first time to claim the 

most Internet users in Asia. During that same year, sales of computers in China reached 17 million in the first nine months, nearly 

twice the 9.17 million sold in 2002. The rapid march of technology 

in China is perhaps the largest factor affecting supercomputing in 

China. China can build its own commodity cluster supercomputers, 

and China’s increasingly a contributing member of the Grid community. In particular, China’s growing supercomputing capabilities 

are independent of U.S. export policies. In the areas of both supercomputing and science, intellectual property protection and limited 

market access will not necessarily deter China’s progress. The 

growth of open source software and the scientific traditions of open 

exchange of information and international collaboration are the 

principal factors enabling science and technology in China, as they 

are all over the world. 

So what does it take to be a leader in supercomputing? 

More than any other factors, the key to leadership in supercomputing today is the ability to make it a national priority and to 

back it up with resources, commitment and planning. For traditional high-performance supercomputing, the top spots in the Top 

500 list demonstrate a multiplicity of architectural models, uses 

and institutional environments. What’s common among them all is 

the commitment of resources applied to their successful development and deployment. 

If you consider the Japanese Earth Simulator, No. 1 in the Top 

500 list since June 2002—some called it computnik in the New 

York Times—the project planning started in 1997 and was funded 

at a U.S. equivalent of about $500 million. That $500 million went 

for hardware development and deployment, housing and maintenance, human support and development, and scientific research. 

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1 Celera Genomics Completes the First Assembly of the Human Genome, http:// 

www.celera.com/celera/pr—1056581295. 

ning, organizational support, and infrastructure for a sustained period of years. 

Today, many countries are working towards global leadership in 

science and technology and are building large-scale national efforts 

to achieve that leadership. The European Union has just put tens 

of millions of dollars into large-scale projects. Japan is following 

the Earth Simulator with a plan to build a very large 25 teraflops 

Grid cluster. 

Three years ago the UK decided to get into the business of Grid 

Computing, middleware and now is a leader in that area. 

In particular, technology leadership in the supercomputing area 

rests on the ability to successfully fund, deploy and integrate resources and infrastructure at the largest scale. Both the United 

States’ and China’s success will be incumbent on an ability to bring 

national strengths and serious resources to build leadership. 

In today’s increasingly virtualized and integrated world, everyone is both a potential resource and a potential competitor. Thank 

you very much. 

[The statement follows:] 

Testimony of Dr. Francine Berman, Ph.D. 

Director, San Diego Supercomputer Center 

Professor and High Performance Computing Endowed Chair 

U.C. San Diego 

Supercomputing and China 

Mr. Chairman and Distinguished Commissioners: 

I am pleased to testify today before the Commission on developments in supercomputing and science. Understanding today’s integrated and global approach to 

technology and science has important implications to U.S. technology policy towards 

China. 

I will begin by discussing the area of supercomputing and the role it plays in today’s science and technology landscape to provide context for these remarks. I will 

then discuss supercomputing in China. I will complete my testimony with some remarks on leadership in science and technology today. 

Supercomputing Today 

‘‘Supercomputing’’ is the highest performing technology that can be brought to 

bear on an individual problem. Over the last 20 years, supercomputing technologies 

have been widely acknowledged as an enabler for new generations of scientific discoveries. The increasing capability for large-scale analysis, modeling, simulation, 

and other key approaches have enabled dramatic progress in a wide spectrum of scientific disciplines and fundamental discoveries in science and engineering. 

Today, supercomputing is accomplished by more than high-performance computers. Modern ‘‘supercomputing’’ applications utilize high-performance computers, 

high-speed networks, large-scale data storage, scientific instruments, and other resources, often in a coordinated way, to achieve breakthrough scientific results. For 

example, the recent sequencing of the Human Genome combined special-purpose 

machines for high-throughput DNA sequencing with large-scale data storage and 

high-performance computers to calculate 500 million trillion base-to-base comparisons. Over 80 trillion bytes of data were produced by the DNA sequencing pipeline 

and were utilized in a genome analysis calculation. The calculation required over 

20,000 CPU (central processor unit) hours, arguably the largest computational biology calculation ever performed at the time.1

Coordination of resources for the execution of an individual application is the 

focus of ‘‘Grid Computing,’’ a software and services technology which allows the 

virtualization of distributed resources. The potential of Grid technologies to link distributed resources for computation, data management, and multi-resource supercomputing has resulted in a global effort in the development and deployment of Grid 

143 

2TeraGrid.org, http://www.teragrid.org/. 3Pacific Rim Applications and Grid Middleware Assembly (PRAGMA), http://www.pragmagrid.net/. 4Distributed European Infrastructure for Supercomputing Applications (DEISA), http:// 

www.deisa.org/. 5SETI@home, SETI@home. 

6SETI@home Status: Search For Extraterrestrial Intelligence (SETI), http:// 

www.straddle3.net/context/int/i—001218.en.html. 7Top500 List and site, http://www.top500.org. 8 ‘‘The LINPACK Benchmark: Past, Present, and Future’’ by Jack Dongarra, Piotr Luszczek, 

and Antoine Petitet. Provides details of the benchmark and performance data for a number of 

machines. http://www.netlib.org/utk/people/JackDongarra/PAPERS/hpl.pdf. 

software and services over the last decade. Projects such as the U.S. TeraGrid,2 the 

Pacific Rim PRAGMA Grid (of which China is a founding member),3 and the European Union’s DEISA (Distributed European Infrastructure for Supercomputing Applications) project 4 demonstrate the potential of Grid Computing as a unifying global concept. 

Most commonly, Grid technologies are used to link stand-alone, high-performance 

supercomputers and data storage, scientific instruments, visualization facilities, and 

other resources. A few applications can achieve supercomputer-level performance 

using collections of less powerful resources alone, for example, SETI@home achieves 

tens of TeraFlops on millions of laptops and PCs.5,6 However, most supercomputingclass applications are not able to tolerate the longer latencies, heterogeneity, and 

dynamism of very large collections of small-scale resources. Instead, they use the 

Grid to link a few high-performance resources, coupling the fast interconnects and 

optimized architectures of today’s high-performance supercomputers with remote 

storage or data-generating scientific instruments across high-speed networks to enable breakthrough results that were not possible a generation ago.Even in the most 

traditional conceptualization of supercomputing, high-performance supercomputers 

themselves are aggregations of key technologies from a global spectrum of sources. 

Today, Chinese supercomputers use imported Itanium chips from Intel and Opteron 

chips from AMD. U.S. supercomputers are made by multi-national corporations such 

as IBM, Cray, and Hewlett Packard, and incorporate RAM made in Korea and other 

semiconductors from Malaysia, Singapore, Taiwan, Japan and elsewhere, as well as 

components made in the U.S. Over the last few decades, a number of different architectural models for high-performance supercomputers have been developed, reflecting complex trade-offs between differing technologies and various alternatives with 

respect to the amount of supercomputer ‘‘real estate’’ devoted to processor power, 

memory and interconnect. 

Leadership in high-performance supercomputers today is typically marked by 

one’s rank in the global Top500 list (www.top500.org).7,8 Of the world’s ‘‘fastest’’ 15 

machines (measured in terms of speed when executing the solution of a dense system of linear equations on a dedicated machine), China’s submission is number 14, 

preceded by thirteen U.S. and Japanese supercomputers, with the top spot occupied 

by Japan’s Earth Simulator. The machines at the very top of the Top500 list are 

generally interconnected aggregations of ‘‘smaller’’ machines, differing in CPU instruction set and high-speed interconnect. Most are programmed using message 

passing, making them similar for the programmer. Vector supercomputers have 

higher memory bandwidth than cluster supercomputers, and address a wide class 

of applications, however vector supercomputers are generally significantly more expensive than cluster supercomputers. Probably the largest commonality between the 

machines at the top of the Top500 list is the considerable commitment, planning 

and funding over a substantial period required to develop and support the human, 

software and hardware infrastructure required for a leadership position. 

In brief, although stand-alone high-performance supercomputers remain at the 

core of modern supercomputing, today’s applications use a broad spectrum of highend resources, integrated by software technologies, and coupled to support new generations of advances and discoveries. 

Science without Boundaries 

Concurrent with the globalization of technology, science today is conducted as a 

‘‘team sport.’’ For the last two decades, the most challenging science and engineering 

problems have been tackled by (often international) teams of researchers drawn together by common interests and expertise. Competition between groups and schools 

of thought is typically much more relevant to scientific discourse than competition 

based on national associations. For example, the 2000 Gordon Bell Prize, established to reward practical uses of parallel processing and given for the best performance improvement in an application, was won by an international team including 

144 

9Gordon Bell Prize, http://www.sc2000.org/awards/. 10Supercomputing Conference Series, http://www.supercomp.org/. 11 Compact Muon Solenoid (CMS) project, http://cmsinfo.cern.ch/; http://cmsinfo.cern.ch/Welcome.html/CMScollaboration/CMScollaboration.html. 12Large Hadron Collider Computing Grid (LCG), http://info.web.cern.ch/info/Press/ 

PressReleases/Releases2003/PR13.03ELCG-1.html. 13 International Virtual Observatory Alliance (IVOA), http://www.ivoa.net; National Virtual 

Observatory (NVO), http://www.us-vo.org/. 14Supercomputing Center of the Computer Network Information Center, Chinese Academy of 

Sciences, http://www.sc.ac.cn/english.htm. 15 Computer Network Information Center (CNIC), Chinese Academy of Sciences (CAS), http:/ 

/www.cnic.ac.cn/english/about/index.html. 16San Diego Supercomputer Center (SDSC), http://www.sdsc.edu/. 17 National Center for Supercomputing Applications (NCSA), http://www.ncsa.uiuc.edu/. 18Pittsburgh Supercomputing Center (PSC), http://www.psc.edu/. 

researchers from the Max Planck Institute for Gravitational Physics in Germany, 

and researchers in the U.S. The prize was awarded to the team for using a globally 

distributed collection of supercomputers to solve Grand Challenge problems in Physics.9 The Gordon Bell competition is part of the first tier ‘‘Supercomputing’’ SC Conference, a technology and computational science-oriented meeting that has become 

a truly international venue. SC integrates globally linked activities during a weeklong technical meeting and exhibition, guided by an international technical program 

committee which in 2003 included distinguished scientists from 10 different countries.10

Apart from individual efforts, many scientific disciplines are coming together as 

global communities in unprecedented ways to use technology to enable new discoveries. In High Energy Physics, scientists from around the world are coming together 

through the Compact Muon Solenoid (CMS) project, an international effort to upgrade the Large Hadron Collider (LHC) at the CERN particle physics laboratory in 

Geneva. The CMS project is one of the largest international scientific collaborations 

in history. Its goal is to bring protons into head-on collision at higher energies (14 

TeV) than ever before achieved. The CMS experiments will allow scientists to penetrate further into the structure of matter and recreate the conditions prevalent in 

the Universe just 10–12 seconds after the ‘‘Big Bang’’. As of mid-2003 2,300 people 

from 159 institutes in 36 countries, spanning Europe, the Americas, Asia, and Australia, were involved with CMS.11 In September 2003, the project launched the LHC 

Computing Grid (LCG), a network of computers and instruments designed to handle 

the unprecedented quantities of data that will be produced by experiments at the 

facility. More than 12 petabytes of data—12 million gigabytes—will be generated 

each year, the equivalent of more than 20 million CDs. The LCG will meet the computational challenge of analyzing and mining this data by deploying a worldwide 

computational Grid, integrating the resources of scientific computing centers spread 

across Europe, America and Asia.12 Analysis of this data will enable breakthrough 

discoveries critical to the entire High Energy Physics community. 

Similarly, the Astronomy community is using the International Virtual Observatory Alliance to federate sky surveys from large-scale telescopes all over the world, 

including telescopes in the United States, Chile, the Canary Islands and Australia. 

The effort will provide a comprehensive whole-sky data collection that can be mined 

and analyzed for new information.13 Federating key astronomical data will make it 

possible to undertake studies that would otherwise require so much time and resources that they would effectively be infeasible. The ability to correlate massive 

data sets over a broad range of wavelengths, spatial scales, and time intervals will 

make it possible to efficiently search for rare and/or complex types of astrophysical 

objects and phenomena, and have already produced new discoveries. 

Today’s team-oriented, global and virtual approach to science and technology provides tremendous potential for advances and discoveries, but is not well-represented 

by traditional notions of ownership, credit, etc. It is within this landscape, that China’s evolving science and technology programs must be considered. 

Supercomputing in China 

China’s rate of growth in supercomputing has been rapid. China has several 

supercomputer centers, the largest of which is CNIS (Computer Network Information Center) at the Chinese Academy of Sciences 14,15 which currently has a staff 

of roughly 170. By comparison, NSF’s supercomputer centers in San Diego (SDSC) 16

and Champaign-Urbana (NCSA) 17 have roughly 400 staff and PSC in Pittsburgh 18

has roughly 90 staff. 

China has the domestic capability to build fast supercomputers and its current 

most powerful supercomputer is based on a commodity cluster model. The Chinese 

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19Top500 list, www.top500.org, compiled by University of Tenessee, University of Manheim, 

NERSC/LLNL; article in People’s Dailyat http://english.peopledaily.com.cn/200311/19/ 

eng20031119—128576.shtml; Recent HPC Activities in China, Asian Technology Information Program Report ATIP03.035a 2003. http://www.atip.org/public/atip.reports.03/atip03.014.pdf. 20Pacific Rim Applications and Grid Middleware Assembly (PRAGMA), http://www.pragmagrid.net/. 21 China National Grid (CNGrid), http://www.csis.hku.hk/clwang/grid/CNGrid.html. 22 China Grid Forum, http://www.chinagridforum.org/. 23GLORIAD Network, http://www.gloriad.org/. 24 Asia-Pacific Advanced Network (APAN), http://www.apan.net/. 25 Asia-Pacific Grid (ApGrid), http://www.apgrid.org/. 26People’s Daily, http://english.people.com.cn/200311/08/eng20031108—127892.shtml.. 

computer, the DeepComp 6800, ranked 14th as of November, 2003. DeepComp 6800 

is built by the Chinese Legend Group Corporation.19 The remaining 8 supercomputers are numbers 82, 90, 141, 163, 188, 435, 443, and 455 on the list and are built 

by Legend, IBM, HP and at Shenzhen University. China’s first appearance on the 

Top500 list was in 1995 with an IBM computer at the China Meteorological Administration ranked 143. It was not until 2002 that the Chinese had a computer ranked 

higher (number 43 at the Chinese Academy of Mathematics and System Science), 

and on the most recent list China’s submission occupies the 14th spot, preceded by 

machines deployed in the U.S. and Japan. 

In addition to high-performance supercomputers, China is also moving into the 

area of Grid Computing. With the U.S. and others, China is a founding member of 

Pacific Rim Applications and Grid Middleware Assembly (PRAGMA),20 and is developing its own national Grid projects, including the China National Grid (CNGrid) 

consortium 21 and the China Grid Forum.22 China also participates in a number of 

collaborative network projects including the GLORIAD project,23 which is linking 

U.S., Russia, and China in a global-ring network used for joint scientific and educational projects, the Asia-Pacific Advanced Network (APAN),24 Asia-Pacific Grid 

(ApGrid),25 and others. 

Technology is receiving a big push in China, as it is all over the world, by access 

to and availability of information through the Internet. China’s increasing interest 

in technology can be seen by its jump in Internet usage: In 2003, China’s Internet 

usage rose 34.5% to 79.5 million web users, exceeding Japan for the first time, to 

claim the most Internet users in Asia. During that same year, sales of computers 

in China reached 17 million in the first nine months, nearly twice the 9.17 million 

sold in 2002, according to industry statistics.26

The rapid march of technology is perhaps the largest factor affecting supercomputing in China. With the success of commodity cluster supercomputers, which 

China can build, and the growth of Grid Computing, China has a growing supercomputing capability, increasingly independent of U.S. export policies. In the areas of 

supercomputing and science, intellectual property protection and limited market access will not necessarily deter China’s progress. The growth of open source software, 

and the scientific traditions of open exchange of information and international collaboration are the principal factors enabling science and technology in China, and 

as they are all over the world. 

What does it take to be a leader in supercomputing? 

More than any other factors, the key to leadership in supercomputing is the ability 

to make it a national priority, and to back it up with resources, commitment, and 

planning. For traditional high-performance supercomputers, the top spots on the 

Top500 list demonstrate a multiplicity of architectural models, uses, and institutional environments. What is common among all of them is the commitment of resources applied to their successful development and deployment. 

Consider the Japanese Earth Simulator, number one on the Top500 list since 

June, 2002. Project planning started in 1997 and was funded at a U.S. equivalent 

of almost $500 million for hardware development and deployment, housing and 

maintenance, human support and development, and scientific research. The Earth 

Simulator architecture is based on a parallel architecture model that has proved 

successful for high-performance codes for several decades. NEC’s version for the 

Earth Simulator incorporates custom-designed chips capable of sustained performance of 35 trillion floating point operations per second (as measured using the 

benchmarks of the Top500 list). The scientific models run on the Earth Simulator 

are optimized community codes used by the ocean and atmospheric global modeling 

community as well as the solid earth community. The project required an investVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00151 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
146 

27The Earth Simulator Center, http://www.es.jamstec.go.jp/esc/eng/. 28Distributed European Infrastructure for Supercomputing Applications (DEISA), http:// 

www.deisa.org/. 29 Enabling Grids for E-Science in Europe (EGEE), http://egee-ei.web.cern.ch/egee-ei/. 30 Japanese Grid information, http://www-1.ibm.com/grid/grid—press/pr—730.shtml. 31 UK e-Science program, http://www.rcuk.ac.uk/escience/. 32 ‘‘The UK e-Science Core Program and the Grid’’ by Tony Hey and Anne E. Trefethen, http:/ 

/www.rcuk.ac.uk/escience/documents/CoreProgGrid.pdf. 

ment of hundreds of millions of dollars and sophisticated planning, organizational, 

and support infrastructure for a sustained period of years.27

Today, many countries are working towards global leadership in science and technology and are building large-scale national efforts to achieve that leadership. For 

example, 

• The European Union has embarked on large-scale pan-European projects to 

build high-performance and Grid technologies. Two major Grid efforts funded 

last year include DEISA (Distributed European Infrastructure for Supercomputing Applications),28 which is connecting existing supercomputing centers into 

a Grid, and EGEE (Enabling Grids for E-Science in Europe),29 which involves 

70 institutions in 27 countries and is focusing on Grid middleware. These two 

large-scale efforts, with total funding of approximately $63 million, include 

EGEE funding of $38 million over two years for software development alone, 

involving ‘‘human infrastructure’’ of some 200 FTE (full-time equivalents). 

• Japan is following its success with the Earth Simulator with a plan to build 

a very large 25+ teraflops Grid cluster connected by high-bandwidth networks. 

Vendors include IBM, which will provide the world’s most powerful Linux cluster supercomputer, to be integrated with other systems to form a massive, distributed computing Grid. The Japanese Grid is intended to enable collaboration 

between corporations, academia, and government and to support research in a 

variety of areas including Grid technologies, life sciences bioinformatics, and 

nanotechnology.30

• Three years ago, the UK initiated a concerted effort to develop leadership in 

Grid Computing and middleware. Today, the UK e-Science program, funded at 

more than $220 million over 3 years, is providing global leadership in many 

areas, including operational Grids and a major effort in open middleware 

(OMII) involving industry and the academic and research communities. The 

OMII vision, funded for 3 years at almost $12 million, is to become a source 

for reliable, interoperable, open-source middleware, and is focused on moving 

research quality software into reliable, robust, usable software.31, 32

Technology leadership in supercomputing rests on the ability to successfully fund, 

deploy and integrate resources and infrastructure at the largest scale; science leadership rests on the ability to do breakthrough work. Today, science and technology 

leadership have become intertwined, and the advances of each bootstrap the other 

to new heights. Both the United States’ and China’s success will be incumbent on 

an ability to bring national strengths and serious resources to build leadership. In 

today’s increasingly virtualized and integrated world, everyone is both a potential 

resource, and a potential competitor. 

Thank you for the opportunity to testify today. 

Co-Chair ELLSWORTH. Thank you so much, Dr. Berman. 

Dr. May, if you will, please. 

STATEMENT OF MICHAEL MAY, Ph.D. 

CENTER FOR INTERNATIONAL SECURITY AND ARMS CONTROL 

STANFORD UNIVERSITY (ENERGY) 

Dr. MAY. Thank you very much. I appreciate the opportunity to 

present this testimony before this Review Commission. 

I want briefly to apologize for the copy of my testimony that you 

have. When I circulated a draft of this testimony to my colleagues 

at Stanford, they made comments, which you can see in the margin. For some reason unknown to me these marginal comments 

survived in your copy when I sent electronically this testimony, but 

it did not survive when I printed mine. So you have an edge on me. 

147 

What I’m going to have to say is not nearly so high tech as what 

you’ve heard so far this afternoon. I can’t cover all of the energy 

sector. I don’t have experience in all of it. I’m going to focus on 

three areas, which are of particular interest: China’s role in the oil 

markets, China’s electricity sector and some of the domestic and 

international factors that support and constrain China’s energy development. I’m going to start with oil. There’s been concern, of 

course, in many publications about Chinese oil consumption draining the world oil resources. 

The world oil resources are not going to be drained, although the 

production of conventional oil is probably going to level off sometime in the next quarter century; opinions differ as to just when. 

That is likely to strengthen the OPEC monopoly or any successful monopoly in the Gulf States. It’s likely to keep prices above or 

around present, very high real levels, and it’s likely to increase investments in synthetic production and alternative transportation 

fuels. This is likely to happen regardless of what happens in China. 

China currently accounts for about 6 percent of world oil consumption and provides about half of that from domestic reserves. 

So it’s not a big factor in the market today. The domestic reserves 

in China are peaking, however. The new domestic sources there are 

uncertain and likely to be expensive. 

Oil consumption in China, as is well understood, is growing 

about four times as fast as oil consumption in the world as a whole. 

If that pattern continues, China should be as large a consumer of 

crude oil as the United States sometime after 2030. 

China, of course, is not alone in the fast-growing consumer of oil. 

It’s the largest of several large and growing Asian oil buyers. It is 

not clear, as I think everyone understands, that this high consumption growth pattern is going to continue uninterrupted for the next 

25 or 30 years. A number of factors could interrupt it. 

It could be economic downturns in China or in the world or both. 

In fact, if you look ahead a quarter century, it’s almost certain that 

there will be some period of economic downturn. The long-term rise 

in the price of oil, which OPEC is maintaining and is likely to 

maintain in the future, could lead China further in the direction 

of favoring fuel economy, a direction in which it has started recently, and in the direction of producing synthetics from its own 

large coal and shale reserves, processes with which China has long 

been familiar. And that same high price is going to give further incentives to the advanced western economies to pioneer new transportation fuels. Even with an uninterrupted growth, even with the 

kind of linear growth that we see in many forecasts, China is unlikely to be as major a factor, as influential a factor in the oil market as the United States is now and is likely to remain. 

The United States has a number of ways to influence the world 

market, as I think we all know. Through buyer power, the United 

States is by far the largest buyer of oil, and it can change that 

through its own internal regulations. Through new technologies in 

bringing oil to market, western companies led by the United States 

companies have lowered the marginal cost of bringing oil to market 

over the past several decades by a factor of four in real terms. And, 

also, the United States is influential, of course, with security and 

other arrangements with suppliers. 

148 

China is trying, but China is unlikely to have enough spare capital and is unlikely to have enough military power to compete along 

all these lines for a number of decades, if ever. What’s more likely, 

I think, is that China is going to continue its present approach, 

which is a mix of strategic and market oil buying. The major effect 

of China on the world oil market, in fact, is likely to be less in their 

buying of oil and more in their pursuit of upstream control of crude 

sources in a variety of places, such as Sudan, Central Asia, Venezuela, Iran, and they attempted in Russia, but were not successful. There is a considerable debate going on in China, which I reference in the references, as to which way to go, whether to rely on 

the market and get the cheapest supply or whether to adopt strategic approaches which might perhaps assure oil supply in difficult 

times. I think they’re going to continue with the mixture. This is 

going to lead them to overpay somewhat for their oil resources. 

And, of course, they’re not the only ones who are overpaying for oil 

resources for strategic reasons. I will say a word about natural gas. 

China is making heavy investments in pipelines and liquefied natural gas facilities in order to increase its current minimal use of 

natural gas. It has some gas of its own, enough to start with; but 

if consumption increases significantly, it’s going to also depend on 

imported gas from Australia, Indonesia, Russia and elsewhere. 

Speaking of Russia, perhaps the most important strategic energy 

development of the past year or two in Asia has been the decision 

by major Japanese utilities to buy gas on long-term contracts from 

Russia. China is considering similar contracts. 

Russia is likely to increasingly come to be a key supplier of gas 

to East Asia as it has long been to Western Europe. It’s not a particularly Chinese development, but it’s a major development with 

respect to strategic use of resources in East Asia. 

Electricity. China has the second-largest electrical power industry in the world today, somewhat less than half the size of the 

United States, measured in terms of generating capacity. The U.S. 

grid isn’t up to 21st century demand, as we noticed recently, but 

China’s grid is not nearly as capable as the U.S. grid, particularly 

not in terms of its ability to transport large amounts of electricity 

reliably across the country. 

China’s commercial electric power is mostly derived from coal, 

about 70 percent, compared with about 55 percent for the United 

States. Most of the rest of the electricity in China is 

hydroelectricity, with small contributions, a few percent, from nuclear and from oil plants. There’s also quite a bit of noncommercial 

electricity generation using various fuels in China. This is likely to 

continue. Coal reserves are inexpensive comparatively and abundant. The main cost of using them is the transportation cost. 

Hydropower is also likely to continue as the second-largest contributor to the electric grid for some time. China is planning several Three Gorges-sized stations to be built successively upstream 

in the southwest. And there’s a question mark as to how fast and 

how many of these are going to be realized. 

So far as technology is concerned and the role of foreign investment, the picture is quite mixed and is changing, not unlike the 

picture elsewhere. 

149 

The largest coal-fueled power plants are modern, with turbo generators and control rooms from vendors around the world—Siemens, Westinghouse, Hitachi, Phillips—as well as indigenous 

equipment. 

They all have electrostatic precipitators, which abate the particulates. Most of those work. None of them, essentially none, have 

desulfurizing equipment, although low-sulfur coal is generally used 

in the larger modern plants. Most of the pollution which you read 

about in China come from smaller and older plants, of which there 

are plenty, and from the direct use of coal for industrial purposes 

in building heating, which is going down in the major cities. It is 

not likely to change very fast. Continuing use of smaller, older 

plants is built in politically in the way power is allocated to various 

plants in China, and it is changing, but slowly. 

Nuclear plants have more than doubled in the past few years, 

but nuclear power remains a very small part of generation at 

around 2 percent compared with 35 to 40 percent for Japan and 

South Korea. 

France, Canada and Russia and China itself have provided most 

of the nuclear equipment. Natural gas-fueled electric generators, 

which are minimal now, are slated for a large increase. Foreign 

suppliers such as Shell, General Electric and BP are providing 

most of the infrastructure. China is increasingly acquiring the technology, but, again, this is proceeding quite slowly. 

As to the factors that support and constrain China’s energy development, the most important factor, obviously, is its economic 

growth. Energy and economic growth are synergistic in all countries. 

The next most important factor affecting the electricity development, and, in general, energy development is the availability or, 

rather, the lack of availability of a long-term capital market. 

In the electricity and gas industries, adoption of efficient, costeffective, less-polluting technology is held back by the lack of ability to sell long-term bonds and stocks. And that, in turn, is held 

back by the lack of transparent accounting to the Chinese and foreign public, something that was touched on earlier in the day. 

As a result, most of the construction is financed by either 15-year 

bank loans, which rules out improvements that only pay off in 30 

to 40 years, or as by government or foreign financing. Direct government involvement has indeed been a major supporting factor in 

introducing modern plants. Without it, energy development would 

lack the market support necessary to keep up with the economic 

growth. I won’t touch on the capital market problem in China given 

the shortage of time, but it’s a deep-seated problem and it is tied 

to the fact that the banking industry and the state-owned enterprises to which the banks make loans are, in general, not financially viable. 

From a technological point of view, the energy industry is not a 

high-tech industry, not yet at least. There’s little that the Chinese 

could not do techonologically if they wanted to and had the capital 

available. They’re on a steep learning curve regarding gas pipeline 

technology and allied technologies. Their electric grid and grid control technologies however are not up to modern standards. Those 

could not support widespread deregulation, which some in China 

150 

are talking about. I don’t think such widespread deregulation is 

going to happen very fast. 

So at the bottom line the major problems in the energy sectors 

in China are transition problems: how to transition to long-term 

private financing, how to transition to less people-intensive operations, how to match infrastructure growth to short-term profitable 

commercial growth. 

So far as resources are concerned, China will probably find itself 

increasingly in a situation of partial dependence on Middle East 

and Russian suppliers, a situation similar to that of other developed countries but, I believe, on a less favorable footing for a longterm time, than the United States. 

I will say one closing word on global climate change. At present, 

China emits about half as much as the United States in greenhouse-gas emissions, about a tenth as much per person; but China’s emissions are growing faster, about 2 1/2 percent per year, 

compared to 1 1/2 percent for the United States and 1 percent for 

the world. China, again, is only one, although the largest, of several large future potential contributors to climate change. Any future aggressive action on this goal is going to create pressure for 

some kind of action on the part of China, India and other less-developed countries. And this, in turn, would inevitably put pressure 

on coal, particularly the inefficient coal applications that are abundant in China and the other LDCs. 

Thank you very much. 

[The statement follows:] 

Prepared Statement of Michael May, Ph.D. 

Professor Emeritus, Center for International Security and Arms Control 

Stanford University, Stanford, CA 94305 

I appreciate the opportunity to present this testimony before the hearing of the 

U.S.-China Economic and Security Review Commission. 

As I understand it, my job is to give the Commission an assessment of the current 

technological capabilities of the energy sector in China; how the sector will develop 

in the future; and what role foreign companies, investors, and scientists and engineers play in the sector. The Commission is also interested in learning what domestic and international factors promote and constrain the development of energy in 

China, in particular any constraints created by inadequate intellectual property protection and market access limitations. Another Commission interest is whether Chinese firms and other organizations are investing overseas as a way of transferring 

technologies to China. 

This is a tall order and I will only be able to address a part of it based on my 

experience in China and with the energy sector and its security dimension in general. I will concentrate on three areas: China’s role in the oil markets; China’s electricity sector; and some of the domestic and international factors that support and 

constrain China’s energy development. In each area I will try to point to one or 

more important bottom lines. 

Oil 

I start with oil, because there has been concern about Chinese oil consumption 

draining world oil resources. World oil resources will not be drained, although production will probably level off sometime in the next quarter century. That will 

strengthen the OPEC monopoly, keep prices at or above present levels, and increase 

incentives for investment in synthetic production and possible alternative transportation fuels. But this is likely to happen regardless of what happens in China. 

China currently accounts for about 6% of world oil consumption and provides over 

half of that from domestic reserves, so it is not a big factor in the market today. 

The domestic reserves are peaking however, new domestic sources are uncertain 

and likely to be expensive, and oil consumption has been growing about four times 

as fast as the rest of the world. If that pattern continues, China should be as large 

a consumer as the US some time after 2030. 

151 

China is not alone in growing fast. It is the largest of several large and growing 

Asian oil buyers. China and other growing Asian countries could become more rather than less dependent on the U.S. and other advanced Western technologies as the 

price of oil stays high or goes higher, assuming the appropriate investments are 

made in the West. 

It is not at all clear that the high consumption growth pattern will continue. Several factors could interrupt it: there could be economic downturns in China or the 

world or both; the long-term rise in the price of oil which OPEC is maintaining and 

is likely to maintain in the future could lead China further in the direction of favoring fuel economy, a direction in which it started recently, and in the direction of 

producing synthetics from its large coal and shale base, a process with which it is 

familiar; and that same high price will give further incentives to the advanced 

Western economies to pioneer new transportation fuels. 

Even with uninterrupted growth, China would be unlikely to become as major a 

factor in the oil market as the US is now and will probably remain. The US influences the market in several ways, through buyer power, through new technologies 

for bringing oil to market, and through security and other arrangements with suppliers. China is unlikely to have enough spare capital or military projection power 

to compete along all these lines for several decades if ever. 

What is more likely is that China will continue its present mixed strategic and 

market approach. The major effect of China on the world market may be felt less 

in their buying of oil than in their pursuit of upstream control in a variety of places 

such as Sudan, Central Asia, Venezuela, Iran and an attempt in Russia. This concern over energy security leads China to overpay for resources. Of course, China is 

not the only country to overpay for strategic resources through various mechanisms. 

A word about natural gas: China is making heavy investment in pipelines and 

LNG facilities in order to increase its current minimal use of natural gas. It has 

some gas of its own, but, if consumption increases significantly, it will also depend 

on imported gas, from Australia, Indonesia, Russia and elsewhere. Perhaps the most 

important strategic energy development of the past year in Asia has been the decision by major Japanese utilities to buy gas on long-term contracts from Russia. 

China is considering similar contracts. Russia may increasingly come to be a key 

supplier of gas to East Asia as it has long been to Western Europe. 

Electricity 

China now has the second largest electrical power industry in the world, at something less than half the size of the U.S. industry, measured in terms of generating 

capacity. Neither grid is in terribly good shape, but, much as the U.S. grid needs 

to be brought into the 21st century, China’s grid is still not nearly as good in terms 

of its ability to transport large amounts of electricity reliably across the country. 

China’s commercial electric power is over 70% derived from burning coal, as compared with 55% for the U.S. The rest is hydroelectricity, with small contributions 

from nuclear and oil plants. There is also significant and poorly measured non-commercial generation, with various fuels. For the future, there is considerable investment in providing gas for combined cycle gas-fueled plants and the nuclear component has more than doubled in the past few years, but coal and hydro are almost 

certain to dominate generation for a decade or more longer. Coal reserves are large 

and the main cost is to provide transportation from the mines to the consuming centers. 

China is counting on more hydropower and planning several Three Gorges-sized 

stations to be built successively upstream in the southwestern area. Their overall 

economic, social and ecological impact is not well known. A more transparent decision-making process may delay the construction. 

So far as technology and the role of foreign investors are concerned, the picture 

is mixed and changing, something that can be said of Chinese industry across the 

board. The largest coal-fueled power plants are modern, with turbo-generators and 

control rooms from such vendors as Siemens, Westinghouse, Hitachi, and Phillips, 

as well as indigenous equipment. They all have electrostatic precipitators, most of 

which so far as I saw are working. Essentially none has desulfurizing equipment, 

albeit they use predominantly low-sulfur coal and there is interest among utility operators in purchasing such equipment from the U.S. and elsewhere if the proposed 

tax on sulfur emissions is adopted. 

Most of the pollution comes from smaller and older plants, some dating back to 

the fifties and of Soviet origin, and from direct use of coal for industrial purposes 

and building heating. A review of changes past and proposed in coal-fired electric 

plants in three provinces shows a bifurcated distribution, with efficient large new 

plants and continued use of locally owned inefficient smaller plants. 

152 

Nuclear plants have gone from 3 to 8 in operation in recent years with 3 more 

under construction, but nuclear power remain a small part of overall generation, 

about 2%, compared with Japan and South Korea where nuclear power provides 

about 35% of total power. Foreign vendors (France, Canada, and Russia) have provided most of the nuclear equipment in the plants but several of the new plants 

are Chinese-built. 

Gas-fired electrical generators, minimal now, are slated for a large increase but 

will not be a big part of generation for the coming five or ten years. Foreign suppliers such as Shell, GE and BP are providing much of the gas infrastructure. As 

in all other cases, China insists on technology transfer rights that will enable it to 

make such equipment itself in the future, in line with what other developing countries have done. 

Factors that Support and Constrain China’s Energy Development 

The most important factor in Chinese energy development is its economic growth, 

the two being synergistically related as in all developing countries. The next most 

important factor affecting the energy development is the availability or lack of a 

long-term capital market. In the electricity and gas industries particularly, adoption 

of less polluting and more cost-effective technologies is hampered by the lack of ability to sell long-term bonds and stocks based on a sound transparent accounting to 

the Chinese and foreign public. Much new construction is financed by 15-year bank 

loans, which rules out improvements that pay off only over the 30–40 year life of 

the plants. Only if government or foreign financing is available are such plants 

built. Direct government involvement, through the state-owned oil, gas and electric 

power companies, has been a major supporting factor. Without this backing, energy 

development would lack market support including but not limited to financing. The 

transition from government operation to market in the energy sector will be a long 

process. 

The capital problem is tied to the problems in China’s banking industry, and, in 

turn, to the State-owned enterprises to which many of the banks’ loans are directed. 

In my visits to utilities and provincial planning groups across the country, this factor has been a continuing presence. The financing problems are also in part due to 

the fact that higher short-term returns are to be found outside the energy industries. 

From a technological point of view, while I am far from an expert in many facets 

of the energy industry, my impression is that there is little that the Chinese could 

not do, given the necessary investments. They are just now getting to manufacturing the largest turbo-generators and they are behind both their Japanese and 

South Korean neighbors in manufacturing nuclear components. They are also on a 

steep learning curve regarding gas pipeline and allied technologies. Their electric 

grid and grid control technologies are not up to supporting widespread deregulation 

and the consequent large-scale trading of electricity. There is a lot of talk and activity along that line, but my impression is that not much will happen, or should happen, very fast. 

A Bottom Line 

The major problems in the energy sectors in China today are economic and political transition problems: how to transition to long-term private financing, how to 

transition to less people-intensive operations, how to match infrastructure growth 

to short-term profitable commercial growth. So far as resources are concerned, particularly oil and gas, China will probably find itself in a situation of partial dependence on Middle East and Russian suppliers, similar to that of the developed countries, albeit less favorable than the U.S. The likely long-term rise in oil prices will 

steer users to conservation and alternative fuels, in which case China will not be 

worse off than others, but technologically advanced countries will have an edge. 

A closing word on global climate change. At present, China emits about half of 

U.S. greenhouse-gas emissions per year, about a tenth as much per person, but China’s emissions have been growing faster, about 2.5% per year versus 1.5% for the 

U.S. and 1% for the world as a whole. Again, China is only the largest of several 

large future potential contributors to climate change. Any future aggressive action 

on greenhouse gas emissions abatement would create pressure for some kind of action for China, India and other LDCs. This would lead inevitably to pressure on 

coal, especially the inefficient coal applications that are abundant in most LDCs. 

I am grateful to my colleagues at Stanford, particularly Professor Thomas Heller, 

Dr. David Victor and Dr. Chi Zhang, for their help and insights. 

153 

REFERENCES 

A comprehensive, easily accessed set of data and analyses on China’s energy situation is the Department of Energy’s Energy Information Administration: http:// 

www.eia.doe.gov/emeu/international/china.html. 

For one of many assessments of the security aspects of China’s energy development, see ‘‘China and Long-range Asia Energy Securities: An Analysis of the Political, Economic and Technological Factors Shaping Asian Energy Markets,’’ Center 

for International Political Economy and the James A. Baker III Institute for Public 

Policy, Baker Institute at Rice University (1999). 

For a discussion of China’s oil strategy and current Chinese debates, see Erica 

Downs, ‘‘The Chinese Energy Security Debate’’ Doctoral Dissertation, Department of 

Political Science, Princeton University, Princeton NJ. Dr. Downs can be contacted 

at Erica Downs <downs@Princeton.EDU>. 

The East-West gas pipeline has a long and complex history. For an early appraisal of difficulties, see Kang Wu ‘‘China’s Decision On Shanghai Gas Reflects 

Pipeline’’ East West Center document February 27, 2001 http:// 

www.eastwestcenter.org/events-en-detail.asp?newslID=25. 

For a brief, recent Chinese status report, see ‘‘West-East Pipeline Starts Commercial Operation’’ People’s Daily, January 19, 2004 http://english.peopledaily.com.cn/ 

200206/24/eng20020624l98429.shtml. 

On Japanese utilities’ plans to buy natural gas from Russia, see James Brooke 

‘‘Japan and Russia Working Hard to Build Economic Ties’’ New York Times January 

23, 2004 

For data and a discussion of electricity industry development in some provinces 

of China, including a discussion of carbon emissions, see Chi Zhang, Michael M. 

May and Thomas C. Heller, ‘‘Impact On Global Warming Of Development And 

Structural Changes In The Electricity Sector Of Guangdong Province, China’’ Energy Policy 29 (2001) 179-203; and Chi Zhang , Thomas C. Heller , Michael M. May 

‘‘Carbon Intensity of Electricity Generation and CDM Baseline: Case Studies of 

Three Chinese Provinces.’’ These papers analyze the forces driving electricity 

choices. 

For a recent update on nuclear power see the World Nuclear Association ‘‘Nuclear 

Power in China’’ January 2004 http://www.world-nuclear.org/info/inf63.htm. 

For more information contact: Michael M. May, mmay@stanford.edu, (650) 723– 

9733 

Panel IV: Discussion, Questions and Answers 

Co-Chair ELLSWORTH. Thank you, Dr. May, Dr. Berman, Mr. 

Dedrick and Mr. Bold. Thank you very much indeed. 

Commissioner Robinson has some questions or a question. 

Chairman ROBINSON. Thank you, sir. Thank you, Mr. Co-chairman. I have a quick question for Mr. Bold and one for Dr. Berman, 

if I might. Mr. Bold, I was intrigued by the—what is a big story, 

that is, that China has gone ahead with its own standard. I can’t 

quite remember the acronym off the cuff, but you’ll forgive me 

there. 

Mr. BOLD. Sure. 

Chairman ROBINSON. But as you mentioned, it’s largely, I would 

guess, based on QUALCOMM’s standard. You mentioned the term 

tweaking with some Chinese vendors and possibly Siemens and 

other foreign suppliers that helped bring this to the floor, that it 

would be exported, that—and then you said something surprising 

to me, that QUALCOMM was basically encouraging of that development. I’m just wondering if there was any kind of residual feeling in the company at a certain point along the trail that the 

tweaking wasn’t altogether copacetic and may have been a little bit 

troubling to QUALCOMM at one time because of the similarity of 

the standards and the feeling that this thing had been built at your 

prodigious expense. 

What was—am I off base there or—— 

154 

Mr. BOLD. Well, to answer that, talk a bit about the nature of 

our intellectual property portfolio and then the nature of the technology in question. CDMA is a spread spectrum technology. It actually—its antecedent is actually some military communications research coming out of World War II dealing with jamming of communications channels. 

What the founders of our company did was took the concept of 

spread spectrum and turned it into a platform for mobile communications. So that the intellectual property to which I referred, I 

used the word essential. And indeed a number of the patents that 

we hold are essential to any spread spectrum technology, any variant of CDMA. And, in fact, there is a variant that is beginning to 

be used in Europe known as wide band CDMA, for which we have 

already consummated a number of licenses with European vendors 

who are paying us royalties for the equipment. So with that as a 

backdrop, it explains why we weren’t terribly concerned when another variant was developed in China. 

Now, this is different still, and I won’t go into the technical details, but basically most cellular systems have what they call a forward and reverse channel. So when you talk on the cell phone, 

your call is going in one direction. Then it comes back in another 

direction from the tower. This variant doesn’t have that feature. So 

it makes it a little bit different still, but it is still a spread spectrum technology, and we have been very public in saying that our 

IPR is essential for it. 

We actually have—we’re a founding member of the TD-SCDMA 

forum, which is group of American, European and Chinese businesses looking to figure out how to develop this technology and 

make it commercial. 

It’s not really clear what applicability it will have either in China 

or other international markets. We believe, for example, it’s not 

really appropriate in the same way that a wide-area network technology like CDMA is here in the United States. 

It might be more useful in smaller areas, like apartment buildings or what have you; but it’s certainly yet to be commercially 

proven. 

The reason I said it’s encouraging is that as a major holder of 

IPRs, it’s good to see the Chinese develop their own IPR, go into 

international markets, have a stake in fair treatment of those IPRs 

in accordance with TRIPS and other agreements. So that’s one of 

the reasons I think we view it favorable. 

Chairman ROBINSON. That makes perfect sense. 

Do you have anything going with Huawei as one of the Chinese 

vendors right now? 

Mr. BOLD. We do. We have a licensing agreement with Huawei. 

And as part of that agreement, we not only have the legal framework that allows them to develop CDMA equipment, we also have 

a number of—and this is true of all Chinese vendors and, in fact, 

all of our licensees—we have a technical consulting relationship 

where we actually work with them to help develop the products. 

Because at one point QUALCOMM, in fact, made the phones. We 

made the network equipment. We’ve got a lot of residual knowledge. And Huawei has, in fact, been one of the more successful 

155 

companies along with, I would say, ZTE in developing fairly innovative products. 

Chairman ROBINSON. Controversial company at some level. You 

know, the Cisco experience and—— 

Mr. BOLD. Sure. 

Chairman ROBINSON. —Air Defense Command in control allegedly in Afghanistan, Air Defense Command in control, Iraq. 

Mr. BOLD. Yes. 

Chairman ROBINSON. And I assume that QUALCOMM is alert to 

that and has safeguards in place and understands the military utility. 

Mr. BOLD. We do. We absolutely do, as does the U.S. Government. 

Chairman ROBINSON. Well, as my time is up, I’ll probably have 

to miss my supercomputer question, but we’ll come back along the 

trail. Thank you. 

Co-Chair ELLSWORTH. Thank you, Commissioner and Chairman 

Robinson. Commissioner and Vice Chairman D’Amato, please. 

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

Dedrick, the Chinese seem to be using their distribution systems 

as a way to encourage and give an unfair advantage to their domestic industries for their own market. Legend has a 30 percent 

market share. 

Is that not a violation of the WTO agreement against unfair nontariff trade barriers? 

Mr. DEDRICK. Well, I’m not an expert on the WTO, but I don’t 

think there’s anything illegal about building your own distribution 

network. The Chinese government didn’t build the distribution network; Legend created its own. The same thing happened in Japan. 

NEC and Fujitsu built their own franchise dealerships and so on, 

and they did it at a time when land was cheap. So they got an advantage that if a foreign company wants to go in now and try to 

do the same thing, it would be much more expensive. Again, not 

being an expert on trade law or anything like that, it doesn’t seem 

to me that it would be relevant since it wasn’t something created 

by the government. 

It’s Legend’s own sort of proprietary network, which gives them 

an advantage in their market. 

Vice Chairman D’AMATO. Yes, but the problem is the government 

won’t give the same kind of distribution rights to competitive companies in the United States, and that’s an unfair trade nontariff 

barrier in violation of the WTO. They’re doing it on automobiles as 

well. It’s a very serious violation. On the question of the VAT tax 

rebate, is it your view that that is also—or is that a violation of 

the WTO ban against subsidies? 

Mr. DEDRICK. Again, I think you have to ask somebody else 

about WTO violations. It’s really not my... 

Vice Chairman D’AMATO. Do you think that the VAT tax rebate 

will tend to force foreign chip companies to relocate into China in 

order to avoid the tax, or is that a purpose of that tax, do you 

think? 

Mr. DEDRICK. I think that there’s a lot of reasons to locate component production in China. Some of it has to do with government 

regulations. I’m not going to say whether this is contrary to WTO 

156 

or anything, not being my expertise, and that may be something 

that would come up in a WTO case. I’m not sure. But I can tell 

you that the computer makers are encouraging their suppliers to 

move into China for various reasons. One is they get local content, 

which government officials like, but also because it lowers their 

cost. The computer industry is very competitive. When you have a 

computer selling for $600, every penny you save counts. And the 

difference in cost between producing in Taiwan and China may not 

be saving that much, but with the kind of margins the companies 

are facing, that may be the difference between making and losing 

company. 

Vice Chairman D’AMATO. I think the VAT tax is 14 percent. Is 

that substantial enough to change a competitive position? 

Mr. DEDRICK. Sure. 14 percent of what would be the question. 

Vice Chairman D’AMATO. Yes, of the price of the good, tax on the 

price of the good. 

Vice Chairman D’AMATO. Do you have, Mr. Bold, any view on 

this or does your company have any view on this question of the 

VAT tax. It’s not really in your domain perhaps. 

Mr. BOLD. No, not so much. Again, as a company that does not 

manufacture, but really is more of a developer of technology, we’ve 

not taken a position on that, no. 

Vice Chairman D’AMATO. One last question. Mr. Bold, has 

QUALCOMM over the last two years or so had any plans to locate 

any new R&D facilities into China? 

Mr. BOLD. No. Our investment in China, we have an office in 

Beijing, is fairly small by multinational company standards, that’s 

primarily involved with sales, business development, marketing. 

We do have some technical teams, but their role is to provide assistance to the Chinese companies, as I mentioned. So it’s not as 

though they’re doing design of products. In fact, QUALCOMM is 

somewhat unique in its concentration of employees here in the 

United States. Very much an idea the founder had to, you know, 

keep the R&D facilities collocated to, you know, basically have 

more interaction. So the overwhelming majority, I think it’s more 

than 90 percent, of our employees are here in the United States, 

and that’s where we do the design. 

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

Chairman. 

Co-Chair ELLSWORTH. Thank you, Commissioner D’Amato. 

Commissioner Wortzel, please. 

Commissioner WORTZEL. Thank you very much for the testimony 

today. 

I have a question broadly about supercomputers that comes from 

Dr. Berman’s testimony. You know, they have great applications 

for missile and weapons design. In the 1980s in particular, the Department of Defense went to great effort to keep the Soviet Union 

from getting them or from being part of a geophysical network because they can be used to model firing points and submarinelaunched ballistic missile applications, but—and you’ve really got 

some interesting facts in there, that China is No. 14 out of the top 

15 right now, and that its supercomputing capability is increasingly independent of U.S. export controls. 

157 

So my question—and I would leave it to any of the three of you 

or all of you to respond, is there any reason today for national security purposes to maintain export controls on supercomputing or 

software applications? Because this has been a real subject of debate in the Congress and particularly in the commerce committees. 

And I would just be interested in your views on it. 

Dr. BERMAN. My own feeling is that with respect to the technology, the design of complicated software systems required to link 

things together and run supercomputers—everyone has the same 

knowledge. It’s a global community. The same information is generally available throughout the academic community. Scientists, 

have much stronger boundaries in terms of their own schools of 

thought, than they do have national boundaries. 

Leadership comes from the ability to prioritize, the ability to put 

resources behind a decision, the ability to make a commitment to 

establishing a priority and to go to the mat with it. 

Leadership today does not come from the technology secret or the 

software secret that one might have that somebody else doesn’t 

have. So I believe that export controls don’t accomplish the purpose 

that you want. 

Commissioner WORTZEL. Well, I appreciate that. 

Dr. BERMAN. I think that the goal that you want is accomplished 

by making sure that the U.S. is a leader. 

I think now the U.S. has immense raw materials and potential 

to keep and maintain leadership, but we’re falling a bit behind because of the priorities we’re putting towards these areas, not because we have secrets or because they have secrets that we don’t. 

Commissioner WORTZEL. Dr. May, please. 

Dr. MAY. Yes. I just want to add one comment to Dr. Berman’s 

comments. The supercomputers of 1980 were no better than what 

you can find in a routine advanced laptop or desktop today. And 

at the time there was reason to be concerned about exporting 

those. Those were necessary to design nuclear weapons or advanced nuclear weapons and the like. Now everybody’s got that capability. And the supercomputer that Francine is talking about, 

enormously more capable and well beyond that and based on generally understood type of principles. 

Commissioner WORTZEL. Well, I appreciate it. I get called a lot 

on these things by staffers, and that’s where I came down. I said, 

don’t bother. You know, that was kind of an intuitive thing. But 

you’ve got a little bit more knowledge about the subject than I do. 

Thanks. 

Dr. BERMAN. You’re welcome. 

Co-Chair ELLSWORTH. Thank you, Commissioner. Commissioner 

Becker. 

Commissioner BECKER. Thank you, Mr. Chairman. 

Two of my questions have already been answered so it makes it 

a little bit easier on me. I have one right now. 

Over the last several years we’ve had other information technology panelists that have talked to us. And we’ve received testimony that American companies or international companies have 

helped China develop sophisticated surveillance techniques in computer blocking which they use to spy on their own citizens for 

whatever reason. My question to you is, would you think this is a 

158 

proper activity for American companies that are located in China 

like yourself? And if not, what would you suggest to stop that or 

to deal with it? 

Mr. DEDRICK. Well, that’s a good question. I think that there’s 

probably limits when an American company sells technology to a 

customer in China to how much they know how the technology’s 

going to be used. 

Certainly if a Chinese customer or government agency or someone wanted a company to go in and say, develop me a surveillance 

technology that I can use to spy on these people, yes, you might 

think that they wouldn’t want to participate in that, but you can 

just develop technologies that can be used for that. You can sell 

technologies that may be used for that. I think that’s almost the 

same issue that comes up with the security question, you know. 

Technology is technology. It’s the person that’s using it or the organization that’s using it that makes the difference. 

And as a vendor, how much control do you have over that? I’m 

not saying that vendors don’t sometimes look the other way or 

something like that, but a lot of times I think they’re selling some 

basic technology and—QUALCOMM sells a tracking technology for 

trucking companies. Well, you can keep track of where all the 

trucks in your fleet are. If somebody wanted to keep track of individuals, they could possibly use a similar technology. 

Commissioner WORTZEL. I had that in the mirror of my car when 

I was in China. 

Mr. DEDRICK. Well, rental cars have that— 

Commissioner BECKER. Have any of your companies ever participated in anything like that? 

Mr. BOLD. We have not, no. 

Commissioner BECKER. Are you aware of other companies doing 

that? 

Mr. BOLD. Not specifically. In the tracking technology that was 

referenced is—well, just in practical terms, it’s a big satellite antenna that goes on the—if you ever drive by trucks, you’re familiar 

with it. On the highway you’ll see what looks like a casserole dish 

on the top of the cab, inverted with a stubby antenna. 

And what the trucking companies do is use that primarily for 

fleet efficiency so they can know where their trucks are, you know, 

at any given time. 

What’s interesting, though, is that it’s now being used by the 

United States Government in limited use for Homeland Security 

applications for tracking hazardous materials carriers. In fact, 

we’ve actually developed a technology, not to go into a commercial 

here, but—that allows for disabling of trucks. If a truck is hijacked 

and you can’t communicate with the cab, you can actually shut off 

the fuel valve. That’s not a product that we’ve introduced in the 

Chinese markets. I’m not aware specifically, you know, of any discussions we’ve had. But it’s hard to know how that would be used 

for, you know, surveillance purposes exactly. It’s really a commercial application. 

Commissioner BECKER. Dr. Berman, anything? Any comment? 

Dr. BERMAN. I don’t have the expertise required to respond to 

this question. 

159 

Commissioner BECKER. We’ve never had a company acknowledge 

that they’ve done such a thing. 

Dr. BERMAN. I think we’re fortunate in the scientific community 

because most scientists freely collaborate with one another and are 

really more intent on cracking the hard problem than they are in 

looking at these other issues. 

Commissioner BECKER. Thank you. 

Co-Chair ELLSWORTH. Thank you, Commissioner Becker. Commissioner Mulloy. 

Commissioner MULLOY. Mr. Bold, I remember—I think Secretary 

Daley was very helpful in getting your technology into China, was 

he not? 

Mr. BOLD. Yes, he was. Yes. 

Commissioner MULLOY. So, in other words, government can play 

a positive role in these things from time to time. 

Mr. BOLD. Absolutely. 

Commissioner MULLOY. Now, this question is for Mr. Dedrick. 

You point out on page 4 of your testimony that China’s drive to create a commercially oriented computer and electronics industry 

began in 1978–1986 with the Seventh Development Plan. In that 

and subsequent plans, China’s electronics industry was given special emphasis and support as a pillar industry that leads the development of the entire economy. Do you think the Chinese were successful in that? 

Mr. DEDRICK. Certainly the electronics industry is leading the 

development of the economy in a lot of ways. 

I think as someone has brought up this morning, sometimes it 

was in spite of the policy. Sometimes it was supported by the policies, as any of the industrial policies—we find that a lot in studying industrial policy in East Asia. We find more unintended than 

intended consequences. And sometimes the unintended consequences are good; sometimes they’re bad. But a lot of times government directed industrial technology policy doesn’t end up going 

exactly where the government thought it was going to go and has 

different impacts. But policies like training engineers, putting resources into infrastructure, the Golden Projects, things like that, 

probably were beneficial. 

Some of the other efforts, like, sort of promoting national champions, were not too successful. 

Commissioner MULLOY. They’re certainly a heck of a lot further 

along in both electronics—in fact, we import a lot of electronics, 

commercial electronics and computer, from China into the United 

States. 

Dr. Berman, you make a similar point in you saying that for 

supercomputers, you really need a national effort. You make the 

point, many other factors, the key to leadership in supercomputing 

is the ability to make it a national priority. And then you talk 

about other governments funding in particular certain sectors of 

the economy because that helps that sector take off and then has 

a lot of add-ons for everybody else. 

Dr. BERMAN. Yes. 

Commissioner MULLOY. So what I’m understanding here when 

we talked about we lost certain industries and people say don’t 

worry about it because we’re moving up the food chain, and we 

160 

heard the pharmaceutical industry in here before, and we heard 

that the Chinese have national policies to develop their own pharmaceutical industry. 

Do you get a sense—do we have—do you have any sense that we 

need some kind of more national understanding of how we’re situated in this global economy and should be thinking more coherently nationally on how we compete in this global economy? 

I would just like to go right down the line: Mr. Bold, Mr. Dedrick, 

Dr. Berman, Dr. May. 

Mr. BOLD. I think greater coherence, greater awareness on a national level of that question is always a good thing. You know, 

there’s a reason that QUALCOMM is located where it is, and that 

reason is the university in which we sit. And the other reason is 

the availability of venture capital that allowed the company to 

grow and become as successful as it has. 

Those are our two core, you know, competencies, our two critical 

advantages. And the extent to which American policy supports the 

continued growth of both basic and applied research in universities 

and the free availability of venture capital through the Tax Code 

and other things, I think it will benefit American competitiveness 

in the absence of some sort of national strategy that we see in East 

Asia and other markets. 

Commissioner MULLOY. Do you have anything to add, Mr. 

Dedrick, or Dr. Berman? 

Mr. DEDRICK. Yes. I agree with that. I think that the strengths 

that we have, we need to build on. Things like venture capital, 

things like our university system, our national innovation system, 

continue to give us leadership. And I think we need to build on 

those. 

I don’t think sort of a—you know, a centrally planned kind of industrial policy in the economy of this size is— 

Commissioner MULLOY. We’re not talking that, no. 

Mr. DEDRICK. And I think the other thing I would call for is more 

of an awareness of what’s happening outside the United States. I 

think people in the U.S., people in the electronics industry and a 

lot of industries tend to be very parochial. 

The U.S. is a big market and people are sort of vaguely aware 

of what’s happening in other parts of the world. And the government, through supporting research and so on, can play a positive 

role in that sense. 

Dr. BERMAN. That’s an excellent question. 

I think in the science and technology area we’re really in danger 

of falling behind. The Japanese Earth Simulator, I think, was a 

wake-up call to this country. 

The fact is that I don’t think we have a coordinated, sustainable 

vision right now for science and technology. There’s a lot of thrashing within the academic community. There’s a lot of thrashing with 

respect to leadership in a number of scientific and technology disciplines. 

The U.S. has been the intellectual leader for many years. Other 

countries are catching up to us because they have sustained effort 

and vision, and, of course, we all share the same global information 

and knowledge. 

161 

So it’s worrisome for the science and technology community in 

the U.S. right now because I think if we don’t get our act together 

and really develop a cohesive, coordinated national vision, that we 

really will fall behind. 

Commissioner MULLOY. Dr. May, do you have anything to add? 

Dr. MAY. I agree with the other panelists. And I would actually 

make it stronger. 

I’m—I guess you would call me a veteran of the Cold War, at 

least in the nuclear aspects of it and others. 

We did not stay ahead because we could keep secrets better than 

the Soviet Union. They kept secrets much better than we did. We 

had open debates on all kinds of things. We stayed ahead where 

we did because we had an open, competitive process which was 

backed by a lot of resources, and we just moved faster on a number 

of fronts, not all fronts. 

And I think that’s true everywhere. The answer to some of the 

concerns which Commissioner Becker and others have raised is, we 

can’t keep this stuff. It’s all over the world. The Chinese can certainly build their own truck- and car-tracking system without any 

help from us and so on. 

We just have to keep moving faster and more intelligently. That’s 

the only answer. And that involves support—continuing our open 

system and support to research and education, reaching all the way 

down to grade school. Our children and grandchildren tend to 

waste many of the formative years which they could spend learning 

more about everything, including math and science. Wholesale reform is what’s needed. Teachers there have to be paid more. The 

whole thing has to be done better. 

Commissioner MULLOY. And it comes at some vision of national 

leadership, doesn’t it, with a vision of where we’re headed? 

Dr. MAY. Yes. 

Co-Chair ELLSWORTH. Thank you, Commissioner Mulloy. Mr. 

Reinsch. 

Commissioner REINSCH. Thank you. Well, first, in light of Commissioner Becker’s last question, I think it’s appropriate just to 

make the point for the record that we’re talking about dual-use 

equipment. Dual-use equipment by definition has two uses: civilian 

and military, or benign and not so benign. This kind of question 

comes up all the time. If we’re going to take the position which the 

United States Government has never taken, that anything that 

might possibly have some not-so-benign application shouldn’t be exported, that would make an enormous change in our policy and 

would have an enormous economic impact. There are always risks. 

The licensing process assesses the risks and tries to make intelligent decisions in light of what those are. In that regard, Dr. Berman, I want to thank you for your absolutely brilliant answer to 

Commissioner Wortzel’s questions about export controls. It saves 

me a lot of work. The last administration came to precisely that 

conclusion and said so. Unfortunately, it said so on January 19th, 

2001, and we didn’t have as much success as we would have liked 

in persuading the current administration to believe that we were 

right. But I’m glad that you and also Dr. May have said what 

you’ve said. 

162 

Perhaps you’ll have more of an impact than we did. Let me ask 

you, Dr. Berman, one question, and then I have one for Mr. 

Dedrick, as well. For you, Dr. Berman, have the Chinese—to your 

knowledge, have the Chinese done any work—are they doing any 

work on vector supercomputing? 

Dr. BERMAN. I was trying to get some information about that before I came today. To my knowledge, the work is really mainly in 

big commodity computers with fast interconnects. 

Commissioner REINSCH. Okay. Thank you. That’s helpful. 

Mr. Dedrick, if I understood you correctly, you seemed to be not 

overly concerned about the likelihood or not expecting the Chinese 

to be effective competitors with us in third markets in the computer area. And I would like to pursue that with you a little bit. 

I guess the first question is, do you know what share Legend or all 

the Chinese PC manufacturers taken together have of the Asian 

market, not the Chinese market? 

Mr. DEDRICK. You mean outside of China? Very little. I think 

Legend sells in Hong Kong, and that’s about it. And the other Chinese PC makers really aren’t active. 

Commissioner REINSCH. My understanding is it was higher than 

that. I guess I’ll have to do some more research. 

Mr. DEDRICK. Well, if you get the IDC data, they’ll say Legend 

is the No. 1— 

Commissioner REINSCH. Get the what? 

Mr. DEDRICK. International Data Corp. puts out the PC market 

share data, and they’ll say that Legend is the No. 1 PC seller in 

the Asia-Pacific region outside Japan, but virtually all their sales 

come in China. 

Commissioner REINSCH. And you think the obstacles to them expanding their market share—forget about the United States for the 

moment—the obstacles to them expanding their market share in 

Asia, Southeast Asia, for example, are what? 

Mr. DEDRICK. They could expand their market in Southeast Asia. 

Southeast Asia is a small market. If you take all of the ASEAN 

countries, that’s a smaller market than China. China is 12 million 

PCs in one year. Now, ASEAN is not close to that. 

So even if China were to compete effectively in, say, ASEAN, it 

wouldn’t change the global competitiveness of the PC industry very 

much, but it may be a stepping-stone. 

When I said at the end that things change, Legend is not competing now. They may not be competing in the U.S. for a while, but 

I’m not saying that this can’t happen down the line. PCs are a commodity product. Anybody can make them. 

You can develop the distribution capabilities and branding, 

which is not easy, but it’s certainly doable. Other companies from 

other countries have done that here in the U.S. Samsung is a great 

example. 

Commissioner REINSCH. Exactly. That’s sort of where I was 

going. People that I talk to in my little corner of the world think 

this is going to be a big issue as early as two or three years from 

now in the United States. 

Mr. DEDRICK. I don’t think in PCs it’s going to be. 

Commissioner REINSCH. Well, we’ll come back in two or three 

years, and we’ll see who was right. 

163 

Mr. DEDRICK. Okay. Fair enough. 

Commissioner REINSCH. Thank you, Mr. Chairman. 

Co-Chair ELLSWORTH. Thank you, Commissioner Reinsch. 

Commissioner Wortzel. 

Commissioner WORTZEL. Dr. Berman, I wanted to ask you one 

question. If you were to look for a place for national leadership in 

this area, which you’ve called for, would it be in the office of the 

science advisor to the President? Would it be in the National 

Science Foundation? Where should the American people look, bureaucratically, institutionally for that kind of national direction 

leadership? 

Dr. BERMAN. That’s an excellent question. You know, I think it 

depends on what your metric for success is. 

If you’re looking for leadership in supercomputing as measured 

by your ranking on the Top 500 list, then I think you want to build 

the biggest computer you can and you want to look to, say, one of 

the agencies.; typically DOE is building, the biggest computers in 

the U.S. And I think you want to look towards making that a priority. 

If your metric of success is that you want to win a Nobel Prize 

in chemistry or physics or something else, technology is the enabler 

there, and I think you want to put your money in a different place. 

For most of us, you know, this is a knee-in-the-curve kind of 

question, and there’s a variety of things you want to do to achieve 

science and technology leadership. What we don’t have today, I 

think, is really sufficient resources and sustained programs. So 

many of the programs are short term with short-term deliverables, 

and you’re really doing things that are relatively small. And the 

other thing that you don’t have is coordination. So the agencies 

shouldn’t be doing exactly the same thing. There should be some 

kind of handshaking agreement about, I’ll build the biggest computers and you’ll handle the open academic community, for example. Or you’ll handle the things that will enable Nobel prizes or 

whatever your metric for success is. And that we don’t see very 

much. 

The agencies have some integration, minimal coordination, at 

best. And the scientific community, I think, suffers and thrashes as 

a result of that. 

Commissioner WORTZEL. Thank you. 

Co-Chair ELLSWORTH. Thank you, Dr. Berman. 

Thank you, Dr. May. 

Thank you, Mr. Dedrick. 

And thank you, Mr. Bold. And thank you, Commissioners. We 

have a promise given this morning for some open mike time. 

Could you come forward and get one of the mikes from the table 

here and ask a question or make a comment or a small, very small 

speech. Time limit. Yes, time limit. I’ll bang the gavel after you’ve 

spoken for 60 seconds. 

Vice Chairman D’AMATO. Don’t be shy, you students out there. 

Co-Chair ELLSWORTH. Don’t be shy. 60 seconds each. 

Okay. There’s a mike that’s being liberated from its rack. 

OPEN MICROPHONE FOR PUBLIC COMMENT 

And, sir, would you identify yourself and your institution. 

164 

Larry PRIOR. My name is Larry Prior, and I’m with a high-tech 

company here in San Diego called Light Point Communications. 

And we build optical wireless systems. So we connect buildings at 

high bandwidth. 

And I really appreciate you coming and spending time in California and San Diego. And I had watched a little bit of what you 

had to go through in South Carolina. And you have just a huge dilemma that most of our economy here in California, and especially 

here in San Diego, is really built on an investment in high-tech 

R&D. And for years we’ve outsourced touch labor. We did it in 

Mexico. We’ve done it in Eastern Europe, and, yes, we’re moving 

things to Asia now. 

And for us to sustain growth here and grow jobs, we’re really dependent on that outsource manufacturing. We have been doing it 

for decades. In contrast, when I see what’s happening in South 

Carolina, they’re going through what we experienced back in about 

1989, 1992. So I think the challenge is, how do you reconcile an 

economy as large as California’s, which is about the size of China’s, 

where we really are critically dependent on riding that growth in 

Asia, growing jobs in California? My company, I’ve raised $70 million since 2000 and grown a 

company from four employees, you know, to 40. And I’m not alone 

in San Diego. How do you reconcile sustaining that while you’re 

still wrestling with the dilemma of the impacts elsewhere in the 

world? So I just wanted to thank you for spending time to get the 

California viewpoint, what we struggle with here in San Diego. 

We’re growing like crazy. We’re dependent on the Asian market, 

and we are growing jobs. 

Co-Chair ELLSWORTH. And isn’t it the case that here in San 

Diego we’re flooded all the time with workers from Asia, from Mexico and from all over the world. People coming in, brainy people, 

strong-armed people. 

Larry PRIOR. If you walk into my facility, it looks like the United 

Nations, as does San Diego. We’re rich in diversity. We really have 

fun with it. So it’s very different from what you’ll see on the East 

Coast. What is fun, though, is we’re growing jobs, and so the model’s working for us. How you sustain that through K through 12th 

grade education, how you help transition a work force from touch 

labor to management of outsourced workers somewhere overseas is 

very difficult. The other thing you should start getting ready for— 

and the question about Legend computers was a great one. They’re 

all coming here now. 

If you think of the evolution of the car industry where you start 

to see BMW opening plants in the United States, you’re going to 

see Chinese manufacturers opening large facilities here in the 

United States, hiring U.S. workers. 

Co-Chair ELLSWORTH. Of course, BMW also makes BMWs in 

South Carolina where they call it Bubba Makes Wheels. 

Mr. PRIOR. So anyway, it’s—— 

Co-Chair ELLSWORTH. Thank you very much. Tell us your name 

again. 

Larry PRIOR. It’s Larry Prior. 

Co-Chair ELLSWORTH. How do you spell it? 

Larry PRIOR. P-r-i-o-r. 

165 

Vice Chairman D’AMATO. Let me just say Mr. Prior is a bit of 

a ringer in a sense because Mr. Prior was on the House Intelligence Committee staff and knows a lot about this whole business. 

Chairman ROBINSON. Just a quick comment, though. I think that 

it is going to have to be a sector-by-sector approach at some level. 

You pointed out profound differences between South Carolina’s experience and that of San Diego and California more broadly. And 

it is a tough challenge because this is not a one remedy suits all. 

It’s going to have to be broken down into sectors and at times regions. And, because the experience across this country is so different vis-a`-vis China—it is—— 

Larry PRIOR. It’s all the appointments from Nancy Pelosi. And 

we’re constantly throwing jobs in her district and doing business in 

Latin America and across Asia. So it’s a huge dilemma. 

Chairman ROBINSON. Well, thank you very much. 

Co-Chair ELLSWORTH. Anybody else for an open mike? 

If not, Mr. Chairman, it’s yours to adjourn or as you wish. 

Chairman ROBINSON. Well, thank you very much, Mr. Cochairman. 

Well, we’ve had an extraordinary day. And, fortunately, it’s not 

over. We’re going to be reconvening at 8:30 tomorrow in this lovely 

facility for China’s role in Asia where we’ll hear from Professor 

Shirk and Ellis Krauss and David Lampton. 

And we’ll get that all-important geopolitical perspective into the 

mix, as well. And I would only say that it’s been a very rich day. 

I’m sure all of my fellow Commissioners would agree. We’re most 

grateful to all the panelists and organizers. 

And we will look forward to seeing all of you who can attend tomorrow morning. And I would like to adjourn the session at this 

time. Thank you. 

(The proceedings were adjourned.) 

FRIDAY, FEBRUARY 13, 2004 

OPENING REMARKS OF CHAIRMAN ROGER W. ROBINSON, JR. 

Chairman ROBINSON. All right. We’d like to bring to order our 

morning session, China’s role in Asia, an integral piece of the complex series of issues at play and what were extraordinary opportunity to hear from the community in this part of the world yesterday. And we’re privileged to have a truly visionary and strong 

panel with us this morning. And I would like to welcome you all 

first and thank you, again, for being with us. 

With that, I think that if you’re willing, we’d like to proceed right 

into our program and hear from Dr. Shirk first, Professor of Political Science at the Graduate School of International Relations and 

Pacific Studies at the University of California, San Diego, as all of 

you know, and one of our hosts for this very special field investigation opportunity on behalf of the U.S.-China Economic and Security 

Review Commission. We thank you again for that. And we’d like 

you to proceed. 

As far as ground rules, I believe we’ll go with a slightly expanded 

version this morning of a ten-minute presentation and five or six 

minutes per Commissioner if that’s acceptable. And we will proceed 

at this time. 

166 

PANEL I: CHINA’S ROLE IN ASIA 

STATEMENT OF SUSAN L. SHIRK, Ph.D., 

PROFESSOR OF POLITICAL SCIENCE 

GRADUATE SCHOOL OF INTERNATIONAL RELATIONS AND 

PACIFIC STUDIES 

UNIVERSITY OF CALIFORNIA, SAN DIEGO 

Dr. SHIRK. It’s a great pleasure to welcome the Commission here 

to the Graduate School of International Relations and Pacific Studies. This morning we are shifting gears a bit and not talking so 

much about China’s relationship with the world and the United 

States as a technology power, but looking more at China’s regional 

policies and its relations with its neighbors in the Asia-Pacific. 

All of us will be talking about that from different angles. My 

focus is China’s policies toward multilateral organizations in the 

Asia-Pacific. This is really one piece of what has proven to be, I 

would say, a very successful approach to regional policy that China 

has undertaken over the past decade or so. 

Let’s remember that at the beginning of the 1990s, China 

didn’t—Asia didn’t—really have much in the way of multilateral organizations. The contrast was with Europe, of course. And after the 

end of the Cold War there was a question of whether or not it 

would make sense to build up some of those regional institutions. 

And one of the major rationales on the part of the United States 

and other Asian countries for building up those kinds of institutions was to try to enmesh China in a web of institutional relationships that might help transform China into a responsible country 

as it grew in power and also to restrain China’s behavior, much as 

the global and Western European institutions have done for all the 

countries that belong to them. 

So this was the idea of, as Jim Shinn at the Council on Foreign 

Relations put it, weaving the net, trying to integrate China into 

these international organizations. 

And the message I bring this morning is that this approach has 

worked better than we could have imagined 10 or 12 years ago, 

that it has worked very well. It’s worked very well in the sense 

that China has really transformed its own attitudes toward working in these multilateral organizations. 

In the early and mid ’90s, China was very suspicious of these regional organizations. China loved the UN because it was a permanent member of the Security Council and it loved its status and influence there, but it was very suspicious of regional organizations 

because it worried that as the largest country in the region and as 

a communist country, that everyone would gang up on China and 

blame China for one thing or another. 

But what happened is that largely through participation in these 

organizations and including not just the formal organizations, like 

the ASEAN Regional Forum or APEC, but also Track 2 processes, 

like the one that we have been organizing here at UCSD since 

1993. 

And the one I’m referring to is the Northeast Asia Cooperation 

Dialogue, which is a Track 2 forum, meaning it’s not official; it’s 

unofficial. But it includes policy-level officials from foreign ministries, even militaries and defense, as well as two academics, five 

people from each of the six countries of Northeast Asia. And, of 

167 

course, we include ourselves there. So it’s the United States, Russia, China, Japan, North Korea and South Korea. 

And what I’ve seen in my involvement in NEACD is that the 

Chinese have transformed their views so they are no longer suspicious. 

In fact, they are very enthusiastic. They are very comfortable. 

They believe that participation in these kinds of multilateral processes is very useful for them because it helps them reassure their 

neighbors and the United States that their intentions are peaceful. 

And, you know, China can talk till they’re blue in the face—or Chinese diplomats can—about how they are not a threat to anyone, 

but the question is, is that a credible commitment or not? And by 

participating in organizations, especially multilateral organizations 

that actually have some teeth, they do reassure people that that is 

a serious commitment to be a peaceful power. 

My written testimony describes the organizations, the ASEAN 

Regional Forum, APEC—the Asia-Pacific Economic Cooperation 

Forum—ASEAN Plus Three, and the Shanghai Cooperation Organization. 

So I’m happy to discuss any of those, but I’m not going to take 

the time to discuss them in detail in my oral remarks. 

What’s interesting is that the Shanghai Cooperation Organization was founded by China. China’s become such a born-again regional multilateralist that it wanted to have its own organization. 

That’s the one with the Central Asian republics and Russia designed primarily to try to reduce the threat of terrorists, or what 

they call terrorists, separatists and extremists, which from China’s 

perspective, they’re all the same. But what’s interesting is that 

China’s leadership of the Shanghai Cooperation Organization,—especially because Jiang Zemin himself was so enthusiastic about 

it—has helped legitimate the whole notion of multilateral cooperation within China’s domestic policy process. 

So, for example, once it agreed to joint exercises in the Shanghai 

Cooperation 

Organization, joint military multilateral exercises, then the PLA 

and the Foreign Ministry was able to move forward to actually 

have Chinese military folks observing and eventually participating 

in multilateral exercises led by the U.S. Pacific Command. 

So the Shanghai Cooperation Organization was a good way of 

moving forward China’s regional multilateral diplomacy. 

Now, there’s debate about what is the significance of China’s 

multilateral diplomacy and why are they doing it? Some people say 

this is really socialization, that they have really acquired new cooperative values through these multilateral organizations. Other people say, no, it’s just a very instrumental strategy designed to enhance China’s influence and eventually to subvert the U.S.-centered bilateral alliance structure. In my view, it’s not an either/or 

situation. Basically, I think that China really has come to believe 

that a collective security arrangement in Asia is preferable to the 

U.S.-centered alliance structure, that the values of cooperative security are superior to the values of a Cold War alliance structure 

based on the idea that two countries are cooperating against a common threat. 

168 

But on the other hand, it’s certainly true that they have real political objectives here. So how should the U.S. respond? First of all, 

it seems to me that the United States should not turn this into a 

contest between cooperative multilateral security and the bilateral 

alliance structure. If we do it that way, we’re definitely going to 

lose because from the standpoint of other Asian countries, those bilateral alliances will not really meet their security needs in the 

way that multilateral institutions can. Secondly, the United States 

should invest more time and energy in our own multilateral diplomacy in the region. 

I can tell you from my own experience in the East Asia Bureau 

of the State Department that the multilateral piece always comes 

last. It’s an afterthought. And it’s very hard to get people out to 

the region to participate in these meetings. 

If we’re going to have a true Pacific community of the sort that 

Peter Cowhey envisioned for us yesterday, it means working with 

our partners in the region to develop these multilateral institutions. 

And, finally, we need to get out there more. 

You know, the U.S. official who has the greatest presence in Asia 

is the CINC because he’s in Hawaii and he’s traveling in the region 

all the time. The tyranny of distance is really a problem. People in 

Washington can get on an airplane and go to Europe for a meeting 

and be home in time to sleep in their own bed. But to get out to 

Asia is much more difficult. 

I think we ought to think about maybe having a deputy assistant 

secretary for regional affairs based in Honolulu or something like 

that, that would give us more of a continuous presence in the region. Not just on the military side, but on the diplomatic side, as 

well. 

And, finally, let me just add, even though it’s a little beyond the 

scope of today’s discussion, that the effect of multilateral diplomacy 

in the Asia-Pacific on China’s own views of its own interests and 

on its behavior is really striking to me. And it suggests that the 

six-party talks that we’ve initiated to work on the North Korea 

problem are really the way to go about it, not to just have the U.S. 

do this alone. And I think in the future we might want to test the 

value of this kind of multilateral approach for bringing North 

Korea out into the world in the same way that we have done with 

China. 

Thank you. 

[The statement follows:] 

Prepared Statement of Susan L. Shirk, Ph.D., Professor of Political Science 

Graduate School of International Relations and Pacific Studies 

University of California, San Diego 

China’s Multilateral Diplomacy in the Asia-Pacific 

Before 1994, China was highly skeptical about the value of participating in regional multilateral organizations. It preferred to deal with its neighbors and with 

the major powers on a bilateral basis. China feared that any grouping of Asians 

would inevitably gang up against it as the largest, most obvious target. China relished its status as a permanent member of the Security Council in the United Nations, but was reluctant to join regional organizations (Johnston, 1990). Over the 

past decade, however, China has become a born-again regional multilateralist. It 

has moved from the sidelines to participate actively in all the various regional mulVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00174 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
169 

tilateral arenas; it has founded new regional organizations on its own; and it has 

given multilateral cooperation a prominent place in its national security doctrine. 

As the organizer of the Northeast Asia Cooperation Dialogue, an unofficial ‘‘tracktwo’’ forum for government officials, military officers, and scholars from the United 

States, Russia, China, Japan, South Korea and North Korea to discuss regional security issues, I have experienced first hand this transformation in Chinese attitudes 

toward multilateral engagement. At the time of the first meeting of NEACD in 

1993, it was easier to persuade the North Koreans to come than it was the Chinese; 

only on the eve of the meeting did the PRC Embassy in Washington D.C. finally 

agree to send a second secretary to attend. In those early days, the Chinese also 

vetoed any proposal for study projects or agenda items that might lead NEACD in 

the direction of greater institutionalization. The young, articulate diplomats from 

the Asia Department of the PRC Ministry of Foreign Affairs (MFA) who began attending NEACD and various official multilateral fora, however, came to recognize 

that regional multilateral engagement offered China valuable foreign policy opportunities. This group of officials has led the way in convincing their bureaucratic colleagues and the Chinese leaders that cooperation in multilateral settings helps 

China reassure others about its intentions and avert hostile reactions to its growing 

power. Today, China has emerged as the leader of Northeast Asian multilateral cooperation in its hosting of the six-party talks on the North Korean nuclear problem. 

While the evidence of China’s growing interest in multilateral cooperation with its 

neighbors is clear, interpreting it is more difficult: What motivates the Chinese embrace of Asia-Pacific regional multilateralism? Is it a credible signal of China’s 

peaceful intentions or a Bismarckian strategy to grow stronger without provoking 

others to combine against it (Goldstein, 2003)? Is participation in multilateral organizations socializing the Chinese into a genuinely cooperative definition of their national security (Johnston, 2003)? Or are the Chinese simply using multilateral diplomacy to pretend to be cooperative while building up militarily in a quest to supplant 

the United States as the hegemon of the region? 

China’s Portfolio of Regional Multilateral Involvements 

The ASEAN Regional Forum (ARF) 

The ARF, founded in 1994, is the only region-wide security organization in the 

Asia-Pacific. The ARF is led by the Association of Southeast Asian Nations 

(ASEAN), not by the major powers in the region, because ASEAN leadership was 

acceptable to both China and the United States. China’s anxieties about joining a 

regional grouping were eased by having the ASEAN’s in charge. The so-called 

‘‘ASEAN way’’ is to emphasize informal dialogue and trust-building over formal 

agreements and concerted action, avoid interference in internal affairs, and operate 

by consensus so that the most cautious member can set the pace. From China’s 

point of view, these elements of the informal, non-institutionalized character of the 

organization (even today it has no secretariat) reduced the risk of a coordinated effort to constrain its freedom of action. 

As an example of ‘‘soft regionalism’’, the ARF has been derided, particularly in 

the United States, as nothing more than a ‘‘talk shop.’’ Yet, its influence on China’s 

foreign policy rhetoric and actions has been substantial. In the beginning, China objected to the establishment of ARF intercessional working groups; but in 1996 it offered to co-chair a group on confidence building methods with the Philippines. After 

initially opposing the notion of preventative diplomacy to mediate disputes by the 

ARF Chair or special representatives, China now supports the concept while seeking 

to carve out the Taiwan issue and its other territorial disputes from it (Johnston, 

2003, p 186). China’s public statements at the ARF now endorse the concept of ‘‘mutual security.’’ When the South China Sea territorial dispute was raised in the ARF 

by the Philippines and the United States, China resisted discussing it in that context; yet the discussions spurred it to intensify its bilateral negotiations with other 

claimants and negotiate a China-ASEAN code of conduct for the contested territory. 

The Asia-Pacific Economic Cooperation Forum (APEC) 

APEC, an organization with broad membership (Chile, Mexico, Peru, Taiwan and 

Hong Kong are among the members), was founded in 1989 with American support 

to promote regional economic cooperation Its showcase event is the annual meeting 

of national leaders where now foreign policy as well as economic issues are discussed. APEC’s declared objective is free and open trade among its industrialized 

members by 2010 and developing members by 2020. China has used its participation in APEC, in conjunction with its entry to the World Trade Organization in 

2000, to signal its commitment to open markets and free trade; The APEC summit 

hosted by Shanghai in 2000 was a lavish coming-out party for the Chinese economy. 

The Americans, Australians, and Japanese have played leading roles in APEC, and 

170 

the organization has a small Singapore secretariat. Still APEC operates according 

to the same informal, consensus-based procedures as the ARF. Despite APEC’s 

value as a forum for leaders to gather annually and for technocrats to exchange best 

practices, it remains an organization with no ability to enforce agreements. The organization has been split between the Anglo-American economies (Australia, Canada, New Zealand, and the U.S.) that want binding agreements for trade liberalization and many of the Asian economies (China, Malaysia) that resist them. (Stubbs, 

2002, p 447 ) Beijing’s lukewarm enthusiasm for the organization is reflected in the 

fact that after the Asian Financial Crisis, instead of trying to extend APEC’s mission to the stabilization of financial markets, China joined with Japan, Korea, and 

ASEAN to create a new mechanism, the Chiang Mai Initiative, that does not include 

the United States. China’s initiative to establish a free trade agreement with 

ASEAN as a group on an accelerated time-table contrasts with the slower pace of 

trade liberalization in the APEC context. 

ASEAN Plus Three 

The notion of an Asian regional economic grouping that excludes the United 

States has been controversial from 1990 when it was first proposed by Malaysian 

Prime Minister Mahathir Mohammad and the United States put pressure on Japan 

and South Korea to reject it. (At the time China was unenthusiastic because it believed that Japan, as the strongest economy in the region, would dominate the arrangement.) Yet ASEAN remained interested in the idea. When ASEAN was arranging the first Asia-Europe Meeting (ASEM) in 1994, it asked Japan, China, and 

South Korea to join it on the Asian side. Planning meetings brought the group together during 1996 and 1997. And the first leaders meeting of ASEAN plus Three 

was held at the margin of the ASEAN summit in 1997. The growth of intra-regional 

economic ties and of an Asian regional identify, as well as an easing of Washington’s 

opposition, were responsible for the emergence of the grouping. 

Just as representatives from the ASEAN plus Three governments were beginning 

to meet, the Asian Financial Crisis plunged the region into recession and galvanized 

the establishment of the grouping. China enhanced its reputation in the region by 

not devaluing its currency and contributing to the International Monetary Fund 

package for Thailand. The Asian countries were dissatisfied with the response of the 

IMF and the United States to the crisis. The United States quashed the Japanese 

proposal of an Asian Monetary Fund. Refusing to be dissuaded, the Asian finance 

ministers met at the margin of the Asia Development Bank meeting in Chiang Mai, 

Thailand, in 2000, and agreed to establish bilateral currency swap agreements (tied 

to IMF conditions, in order to satisfy the U.S.), an early warning system on shortterm capital movements, and a common position on the international financial architecture. Subsequent meetings of economic ministers have created a number of additional practically-oriented cooperative projects. As the rising economic power in 

the region, China has used ASEAN plus Three to enhance its influence. It has encouraged the expansion of the group’s agenda beyond economic issues to the point 

where the organization appears likely to eclipse the ineffectual ARF and APEC. In 

addition to annual leaders meetings, the ministers of finance, economics, and foreign 

affairs also meet regularly. China proposed a ministerial meeting on cooperation to 

combat terrorism and transnational crime that was held in January 2004. Wellaware of the risk that ASEAN plus Three could come to be viewed as an effort to 

marginalize the United States, China recently has recalibrated by proposing to beefup the security dimension of the ARF by holding an annual security policy conference for defense officials. 

A crucial element in the success of ASEAN plus Three is that China has used it 

to try to mend relations with Japan. Previously China sought to limit Japan’s regional profile by refusing to engage it in discussions on security and political issues; 

a 1997–8 Japanese-American proposal to build confidence by holding three-way 

talks with China was rejected by China. (A senior Chinese Foreign Ministry official 

explained privately to me that it was because Japan ‘‘wasn’t a real power like the 

United States and China.’’) China began consultations with Japan and Korea in the 

context of ASEAN plus Three insisting that they be limited to economic topics, but 

over time it has taken the lead in expanding the agenda to political and security 

issues. 

The Shanghai Cooperation Organization (SCO) 

In 1996, China joined with Russia to found the SCO (originally called the ‘‘Shanghai Five’’) whose members now include, along with the two powers, Kazakhstan, 

Kyrgyzstan, Tajikistan, and Uzbekistan. The organization grew out of the lengthy 

negotiations between China, the Soviet Union, and the Central Asian Soviet republics to resolve their borders. When these republics became independent countries, 

171 

China sought to make the grouping permanent. Its main goal is to gain the cooperation of these new governments to reduce the threat of Muslim separatism in its 

Western provinces. The charter of the SCO, signed by President Jiang Zemin and 

his counterparts in 1996, pledges that all its members will cooperate to combat ‘‘terrorism, separatism, and extremism’’ which in Chinese eyes are more or less synonymous. The charter also contains agreements for specific confidence-building measures similar to that of the Conference on Security and Cooperation in Europe. 

(Johnston, 1993, p 128) 

China is extremely proud of the SCO, the first international multilateral organization it has founded itself. As a ‘‘home-grown’’ organization, the SCO has helped 

build domestic support within China for multilateral diplomacy. For example, the 

SCO charter signed by President Jiang envisioned joint exercises, something China 

had never before agreed to. (The first SCO exercises were held in 2003.) The promultilateralists in the Asia Department of the Foreign Ministry and the PLA used 

the SCO precedent to get internal agreement on China’s participation in joint military exercises with other countries, including the United States. China also first embraced the concept of mutual security (see below) in the context of the SCO, and 

having taken ‘‘ownership’’ of it in this way, promoted it as a positive precedent for 

the rest of the Asia-Pacific. With China’s backing, the SCO is becoming more institutionalized than other regional multilateral organizations, with a secretariat in 

Shanghai and a counter-terrorism center in Bishtek. 

In addition to these organized multilateral activities, China has also initiated free 

trade diplomacy with ASEAN and with Japan and South Korea to signal that it is 

a benevolent regional power. Having been required to open its domestic market 

much wider than many of its neighbors as the price of its entry to the World Trade 

Organization, it is relatively inexpensive for China to move toward free trade in 

many products and services with these neighbors. 

Another positive signal is China’s new willingness to join multilateral military activities including those led by the United States and its allies. The People’s Liberation Army has sent observers to the large exercise known as Cobra Gold in Thailand, as well as to joint submarine rescue and mine-sweeping exercises. Beijing’s 

only limitation is that the exercise must involve a non-traditional (i.e. non-combat) 

mission. Eventually, as its skills and equipment are upgraded, the PLA intends to 

go beyond observing to actually participating in multilateral military exercises. It 

has already held bilateral joint exercises and has invited groups of countries to observe its own exercises. It even has proposed joint military exercises with the 

United States. 

A New Security Concept 

Beginning in the mid-1990’s, Chinese scholars, encouraged by the Asia Department of the Ministry of Foreign Affairs, began to develop a theoretical rationale for 

China’s multilateral diplomacy. They articulated a ‘‘new security concept’’ based on 

mutual security and contrasted it with traditional and cold war security concepts 

based on realpolitik. The key element of the new concept is the notion of ‘‘win-win’’ 

positive sum security, meaning. that a country is more secure if its neighbors also 

feel secure. A report commissioned by the MFA on this concept acknowledged that 

in addition to China’s rise its actions on the ground also were causing other states 

to perceive a threat from China; China needed to demonstrate to its neighbors that 

it adhered to the existing rules of the international order. Greater activism in multilateral activities would signify that it was a status-quo power (Johnston, 2003, p 

130). The new security concept was incorporated in the 1998 PRC White Paper on 

National Defense. 

Guided by this new security concept, China’s multilateral diplomacy is no longer 

reactive and defensive. In the early 1990’s China joined regional groupings created 

by others only because it did not want to be left out. After ten years of experience 

in such groupings, China now has an affirmative commitment to multilateral cooperation in the region and confidently takes its own initiatives to strengthen it. 

Motivations for Multilateral Diplomacy 

Foreign observers largely agree that China’s primary motivation for its participation in regional multilateral processes is to reassure its neighbors and the United 

States about its benign intentions. China recognizes that its growing economic and 

military capabilities create perceptions of a ‘‘China threat.’’ Over time, it has also 

come to realize that simply denying that it has any aggressive intent is 

unpersuasive. Its statements of non-aggressive intent are made more credible by its 

cooperative actions. By joining multilateral organizations and taking multilateral 

initiatives China builds a reputation as a ‘‘responsible power’’ and heads off hostile 

reactions to its growing might. 

172 

Observers differ, however, as to whether China’s multilateral diplomacy is a carefully cultivated effort to advance national interests by ‘‘reassuring those who might 

collaborate against a putative China threat’’ (Goldstein, 2003, p 73), or a genuine 

conversion to mutual security values inculcated by the experience of participating 

in multilateral processes (Johnston, p 132). It is difficult to find empirical evidence 

to distinguish the two interpretations, and indeed, both may be occurring simultaneously. 

For example, China may promote multilateral security cooperation in Asia for a 

number of instrumental reasons: not only as a mechanism for reassuring its neighbors, but also eventually to replace the U.S.-centered system of bilateral alliances 

with a cooperative security architecture in which it plays a leading role. (Western 

Europe was similarly motivated to integrate Eastern Europe into the CSCE as a 

way of attenuating Soviet influence in the region.) Yet China’s foreign policy officials 

and members of the unofficial policy elite may believe sincerely that the values embedded in multilateral cooperation are superior to the values embedded in the U.S. 

bilateral alliances that originated during the Cold War. Realpolitickal pursuit of national interest does not preclude an idealist commitment to the values of 

multilateralism. 

Consequences of Multilateral Diplomacy 

When the United States was a rising power after World War II, it was able to 

convince other countries that it would not threaten them by creating multilateral 

global institutions and submitting itself to the authority of these institutions. By 

binding itself to international rules and regimes, the United States successfully established a hegemonic order (Ikenberry, 2001) Could China’s participation in global 

and regional multilateral institutions have the same result, enabling China to rise 

to power without provoking a concerted effort to contain it? 

Some of the global regimes that China has committed to, in particular the NonProliferation Treaty, the Comprehensive Test Ban Treaty, and the World Trade Organization, embody specific rules and mechanisms for enforcing them. These regimes effectively restrain Chinese behavior and build international confidence that 

in some important respects, a strong China will not harm the interests of other 

countries. 

The multilateral processes established in the Asia-Pacific region, in comparison, 

have much less binding force. Organizations like ARF, APEC, and ASEAN plus 

Three aim to use dialogue to create a normative influence on the actions of their 

members, but they have not yet established either specific rules or the mechanisms 

to enforce them. If China’s multilateral diplomacy turns out to be ‘‘cheap talk’’ designed to lull others into believing that its rise is non-threatening until it has the 

capability to achieve its territorial objectives and dominate its neighbor, ARF, 

APEC, and ASEAN plus Three have no mechanisms to restrain it.. From the standpoint of China’s neighbors, the country’s activism in multilateral settings is a reassuring signal but not a guarantee of non-aggressive actions. Interestingly, the SCO, 

the one regional multilateral organization that China has founded itself, has the 

most specific rules and is moving in the direction of greater institutionalization. 

This fact suggests that after a decade of experience with multilateral diplomacy, 

China might not object if other Asian countries now sought to protect themselves 

by making regional organizations more institutionalized and rule-bound. While proposals to give regional organizations more teeth are likely to gain more traction if 

they are proposed by Asian governments and not by the U.S. government, the U.S. 

would gain by supporting them even if they mean restricting its own autonomy. 

REFERENCES 

Avery Goldstein, ‘‘An Emerging China’s Emerging Grand Strategy, A NeoBismarckian Turn?’’ in G. John Ikenberry and Michael Mastanduno (eds), International Relations Theory and the Asia-Pacific (New York: Columbia University 

Press, 1993), pp 57–106. 

G. John Ikenberry, After Victory: Institutions, Strategic Restraint, and the Rebuilding of Order after Major War (Princeton: Princeton University Press, 2001). 

Alastair Iain Johnston, ‘‘China and Arms Control in the Asia-Pacific Region,’’ in 

Frank C. Langdon and Douglas A. Ross (eds), Superpower Maritime Strategy in the 

Pacific, (London: Routledge, 1990), pp 173–203. 

Alastair Iain Johnston, ‘‘Socialization in International Institutions: The ASEAN 

Way and International Relations Theory,’’ in G. John Ikenberry and Michael 

Mastanduno (eds), International Relations Theory and the Asia-Pacific (New York: 

Columbia University Press, 1993), pp 107–162. 

173 

Richard Stubbs, ‘‘ASEAN Plus Three, Emerging East Asian Regionalism?’’ Asian 

Survey, Vol. 42, No. 3 (2002), pp 440–455. 

Chairman ROBINSON. Well, thank you very much, Dr. Shirk. 

That was a fascinating set of remarks. 

Dr. Ellis Krauss is going to be up next, who is professor of political science at the Graduate School of International Relations and 

Pacific Studies at the University of California, San Diego. 

We look forward to your remarks. 

STATEMENT OF ELLIS S. KRAUSS, Ph.D. 

PROFESSOR OF POLITICAL SCIENCE 

GRADUATE SCHOOL OF INTERNATIONAL RELATIONS AND 

PACIFIC STUDIES 

UNIVERSITY OF CALIFORNIA, SAN DIEGO 

Dr. KRAUSS. Thank you. Thank you for having me. 

My talk today, as those of you have read in my written remarks 

know, is about Chinese-Japanese relations. And to a large extent 

I think these are going to influence the U.S.-China relationship to 

a much greater extent than most people realize and especially since 

there have been profound changes in that relationship during the 

last ten years that have gone very unnoticed in the United States. 

As T.J. Pempel and I in a recent book argue, it is very difficult 

these days to find an issue between the U.S. and Japan that does 

not in some way actually or potentially involve China. In many 

ways the relationship has become somewhat trilateral, rather than 

bilateral. And yet we continue to focus a lot of our attention on the 

bilateral U.S.-Japan relationship. 

The changes that have occurred in the Chinese-Japan relationship are going to shape and create dilemmas and challenges for 

American policy in the future, I believe. These changes have come 

about in part because of China’s growing economic and security inVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00179 Fmt 6633 Sfmt 6602 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128

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174 

fluence in the region and power, and in response, Japan’s reaffirmation of the U.S.-Japan security treaty and moving ever closer to 

the United States militarily. Both of these have provoked shifts or 

been manifested as shifts in Japanese public opinion toward China, 

in the Japanese political elites’ attitudes and behavior toward 

China and China’s, therefore, response to these, developing new 

concerns in China. 

I think there are four important dimensions to the China-Japanese relationship, both historically and at present. 

The first is the one that we don’t talk about much in the U.S., 

but it’s the historical memories aspect. And that is, the continued 

deep distrust and fear that many in China have toward Japan because of its behavior during the Pacific War. Not many Americans 

know that China suffered 13 million deaths, civilian, during the 

Japanese aggression in China. As some have pointed out, this is 

more than the Nazis caused in Europe. 

And in contrast to Germany, which has forgiven and accepted as 

a valued member of the European community, in part, because of 

the much earlier development of multilateral organizations there, 

these feelings in China toward Japan have remained quite strong. 

A public opinion survey, as I point out in my report in 2000, 

showed that only 5 percent of them saw Japan as reliable, less 

than 10 percent saw Japan as peaceful, only 16 percent saw Japan 

as Democratic, yet 44 percent saw them as headstrong, 27 percent 

still saw them as aggressive. This is despite 60 years of peaceful 

behavior on the part of Japan. And for most of the post-war period, 

the Japanese government has been very sensitive to the feelings of 

Chinese on this score. And the Chinese, in turn, have tried to use 

the so-called history card against the Japanese as leverage in negotiations. 

However, there have been profound changes in this regard in 

Japan. The Japanese public, according to public opinion surveys, 

has had a increasingly negative view of China ever since the 

Tiananmen Square incident in 1989, and it has not gone back up 

since. It had a very positive view before that. And the Japanese 

government is taking in a much more nationalistic line on the history issue, to a large extent growing impatient with the Chinese 

use of this issue in negotiations and rejecting—increasingly showing impatience toward the Chinese on this issue. The second dimension would be the economic integration dimension. It is no exaggeration to say that the Japanese have always believed that the 

best way to open up China and liberalize it is a long-term strategy 

of economic development in China. They have not put as much 

faith in socialization or military deterrence as the United States. 

Trade with China has started before it did with the United 

States and has risen to extremely high levels. $85 billion in 2001, 

as you probably know. 

You may not know that Japan is running a heavy trade deficit 

with China of about $27 billion of that. 

Foreign direct investment in China by Japan is not as high as 

the United States or Taiwan or Hong Kong, for example, but it’s 

very difficult to measure that because many of the business concerns in Hong Kong and Taiwan, for example, are Japanese and 

thus there is also indirect FDI. 

175 

China is Japan’s second-largest target of foreign aid—10 percent 

of Japan’s total foreign aid in the world goes to China. And during 

the Cold War Japanese policymakers were very sanguine about 

their ability to manage and handle China because of their economic 

relationship and presumed blood and cultural ties. 

This has now changed for various reasons. China is increasingly 

seen not as an opportunity, but as a threat economically. 

Briefly, the reasons are, China’s increasing manufacturing proficiency, which is attaining Japanese levels, and thus making 

China a potential competitor to Japan; the hollowing out of Japanese domestic industry, including many small and medium enterprises that are now manufacturing in China; trade issues, textiles, 

but especially the agricultural trade war in December 2001. And 

Japanese taxpayers are now questioning why their government 

gives so much foreign aid to China when it is no longer really a 

developing nation, but, rather, a competitor. 

The third dimension, and maybe the most important, is the U.S.- 

Japan relationship and security in which China had a rather ambivalent attitude toward the US-Japan Mutual Security Treaty, at 

least to some extent since 1972; however, it seems to have considered the U.S.-Japan security treaty, in part, a ‘‘cork in the bottle,’’ 

in that famous phrase. It had potential utility in restraining Japan 

from becoming an independent military power again and restraining Japanese nationalism. Recently, however, with Japan becoming 

much closer to the U.S. militarily, including strengthening our alliance and cooperating on theater missile defense, some in China 

have started to see, much more strongly, I believe, the U.S.-Japan 

alliance as an eggshell, rather than a cork in the bottle. An eggshell meaning it is covering and hiding the nurturance behind the 

scenes of a monster that is going to hatch, namely, Japanese militarism again. And Japan is a military power. 

At the same time, Japan has become very dependent on China 

in issues like the North Korean nuclear issue in which China is 

playing a major role as a mediator. 

And also, Japan’s abduction issue, which doesn’t get much play 

in the U.S., but which, in fact, is an obsession of the Japanese public. North Korean agents, as you may know, kidnapped several Japanese citizens since the 1970s. Some have been returned. But their 

children are still in North Korea, and the Japanese government 

and public and media are fascinated by and obsessed about getting 

these people back. The fourth dimension is the territorial disputes, 

and, of course, the most important being Taiwan, although there 

are others. I don’t go into it much in my paper, but there are conflicts, territorial conflicts between China and Japan over the East 

China Sea and the South China Sea. But the most important one, 

of course, is Taiwan. In 1969 the Sato-Nixon communique ́ seemed 

to imply that the security treaty applied to Taiwan. But China 

didn’t make a big issue of it after that and neither did Japan, and 

the issue lay dormant. 

However, in the new guidelines surrounding the implementation 

of the security treaty between—the revision of the security treaty 

guidelines between the U.S. and Japan, the phrase ‘‘defense cooperation in areas surrounding Japan appeared,’’ ‘‘shuhen’’ in Japanese. 

176 

1 Ellis S. Krauss and T.J. Pempel, eds., Beyond Bilateralism: U.S.-Japan Relations in the New 

Asia-Pacific. (Stanford: Stanford University Press, 2003), p. 307. 

The Chinese are very concerned, I believe, that this means that 

the security treaty now can be applied to Taiwan. Japan’s response 

to this issue has been to keep the meaning of that phrase intentionally vague. It has said that areas surrounding Japan is not a 

geographic designation, but, rather, one that will be decided depending on the extent to which and how—and the circumstances 

threaten Japanese security. 

In other words, what the Japanese are doing are not encouraging 

China to take over Taiwan by saying clearly that this treaty does 

not apply to Taiwan, but neither, on the other hand, is it going to 

reassure—it is going to keep its options open that it might apply 

to Taiwan in order to deter Chinese aggressive behavior toward 

Taiwan. 

Combined with theater missile defense’s potential application to 

the defense of Taiwan, these are of increasing concern to the Chinese government. 

I have, like, ten seconds left. So let me just say that there are 

a lot of ironies in this situation, which I point out in my paper, the 

current changes. And there are also many dilemmas that the 

United States are going to face as a result of these changes in Chinese-Japanese relations. 

Thank you. 

The statement follows:] 

Prepared Statement of Ellis S. Krauss, Professor 

Graduate School of International Relations and Pacific Studies 

University of California, San DiegoBefore the 

China’s role in Asia 

Much attention in the U.S. and elsewhere is being focused on the rise of China 

as an economic, military, and political ’player’ in Asia and its implications for the 

United States. It would be a mistake, however, to see the U.S.-China relationship 

in a ’cocoon’ separated from the broader relationships and trends in the Asia-Pacific 

region. For better or worse, China’s relationships with its Asian neighbors are going 

to deeply concern, implicate, and involve the U.S.—they have inevitable consequences for U.S.-China relations and American foreign policy toward China and 

the region. 

None of China’s neighbors is as crucial to the U.S. and to the region as Japan, 

and no other relationship of China’s, other than that with the U.S., is as important 

to China as that with Japan. As T.J. Pempel and I argue in a recent book: 

Even though the U.S. and Japan are as close as ever economically, and perhaps 

even closer militarily, each must now consider the other’s actual and potential 

relationship with China on almost every issue arising between them. No longer 

can the other’s exclusive vested interest in, and likely agreement with, their 

long-time partner be taken for granted and presumed to take primacy across 

Asia.1

China-Japan relations increasingly will be a major influence on and shaper of relations between China and the U.S. and of relations between Japan and the U.S. 

Indeed, it is not much of an exaggeration to say that in the current post-Cold War 

Asia Pacific, the U.S., China, and Japan, relations are today about as much trilateral as bilateral. Therefore, it is essential to understand the areas of conflict and 

cooperation in China-Japan relations to fully comprehend issues in China-U.S. relations, and to understand fully the dilemmas and challenges the U.S. confronts in 

its future relations with China. 

177 

2 Yumiko Hara and Takehiro Shioda, ‘‘Images of the Other Country and Media Coverage,’’ 

NHK Broadcast Culture Research Institute, Features No. 12 (Summer 2000), Figure 13; available on the web at http://www.nhk.or.jp/bunken/bcri-news/bnl-s-feature.html. 3 Reinhard Drifte, Japan’s Security Relations with China since 1980 (London and New York: 

RoutledgeCurzon, 2003), p. 21. 

Background: 1945 to mid-1990s 

The China-Japan relationship in the postwar era has tended to revolve around 

four issue dimensions: 1) ‘‘historical memories’’ 2) economic interdependence 3) the 

U.S.-Japan relationship and security 4) Territorial issues, especially Taiwan. 

1)‘‘Historical Memories’’: To fully understand China’s relations with its neighbor Japan it is necessary to comprehend the deep and abiding antipathy, distrust, 

and fear that many Chinese feel toward Japan because of its behavior in the Pacific 

War. Although the exact numbers will never be known for sure, estimates are that 

China suffered over 1.3 million military deaths and perhaps as many as 13 million 

civilian deaths as a result of Japan’s invasion of China in 1937 and the subsequent 

eight-year war that only ended with Japan’s surrender to the U.S. in 1945. The extent and number of atrocities on civilians committed during this war also remains 

both unnumbered and numberless. In ‘‘The Rape of Nanjing,’’ in December 1937, 

perhaps as many as 300,000 civilians lost their lives in several days of rampage, 

brutality, rape, and murder by uncontrolled Japanese troops. About 10,000 Chinese 

as well as Russian, Korean, and Mongolian civilians were used as guinea pigs, infected with plague, cholera and anthrax bacteria in biological weapons experiments 

by the infamous Unit 731 near Harbin. Millions lost loved-ones, homes, relatives, 

and due to Japan’s aggression. 

It is not surprising that this period is remembered with bitterness by many Chinese. What is surprising is that even after nearly 60 years, these memories have 

been, and still are, used as a yardstick by many among the public to judge postwar 

Japan, a nation that has been transformed into a peaceful, democratic nation with 

a ‘‘Peace Constitution’’ and no offensive military or combat operations since then. 

In a 2000 public opinion survey of adults concerning images of the other country, 

although about a majority or more of Chinese saw Japan ‘‘prosperous’’ as a country 

and its people ‘‘diligent’’ and ‘‘courteous,’’ only 9% saw the country as ‘‘peaceful’’ and 

16% ‘‘democratic,’’ and only 6% saw its people as ‘‘peaceful,’’ 5% as reliable, even 

while 44% saw them as ‘‘headstrong,’’ and 27% saw them as ‘‘aggressive.’’ 2 China’s 

government also has played the ’history card’ often in its dealings with Japan and 

used it as a lever to extract concessions from the Japanese side. 

Such continuing Chinese fears and uses of the ‘‘history card’’ must be seen in 

broader comparative context. In Europe multilateral institutions like NATO and the 

EC (Later EU) were formed and enmeshed Germany into a community of nations 

which would preclude any independent future military expansion on its part (many 

believe these institutions were, at least in part, designed intentionally for this purpose, whatever other goals they had). Increasingly, Germany’s neighbors were reassured that the past could never be repeated. Japan was not embedded in such multilateral frameworks after WWII., and Japan’s neighbors, especially China and 

Korea, never came to be completely reassured about Japan’s future potential as an 

aggressor, despite its ‘‘Peace Constitution,’’ its democratic government, and its nonthreatening behavior. Indeed, the one reassurance of an external restraint on Japan 

might be the U.S.-Japan alliance and the possibility that the U.S. provision of security to Japan would serve as a constraining influence on any future independent and 

unrestrained Japanese militarism. 

2) Economic Interdependence: Even while the Chinese public has held these 

continuing negative and fearful attitudes toward Japan and the Japanese, and the 

Chinese government was using historical memories as a bargaining lever with 

Japan, trade with Japan and Japanese investment in China was proceeding apace. 

Even before normalization of relations between the two countries and the establishment of official diplomatic relations, in the 1950s they were engaged in trade 

through semi-official channels (although severely restricted by COCOM export controls during the Cold War) and after 1962 through a semi-official, 5-year agreement 

(L-T Trade, as it was called). Indeed, Japan was the only country in the world at 

this time to freely trade with both Taiwan and China.3

With the establishment of normal relations in 1972, trade expanded greatly, especially after the Chinese government’s more moderate course after the late 1970s. 

During much of the next two decades, Japan was one of China’s largest trading 

partners, reaching over $20 billion dollars total per year (with the balance substantially in China’s favor) in the early 1990s and by the end of the decade almost $60 

178 

4 Ibid, pp. 23 and 135; ASEAN-Japan Centre Web site Table II–2 ‘‘Japan, ASEAN, and China’s 

Major Trading Partners (2001), http://www.asean.or.jp/general/statistics/02trade/02.html. 5 ASEAN-Japan Centre, Table IV–8–10 ‘‘Investment to China,’’ at http://www.asean.or.jp/general/statistics/04investment/08–10.html. 6 Ibid., Table I–10–1 ‘‘Types and Geographic Distribution of Aid (2001), http://www.asean.or.jp/ 

general/statistics/01basic/10–01.html. 

billion dollars, and over $85 billion by 2001(again with Japan running a heavy trade 

deficit).4

Japanese investment in China lagged far behind trade and American investment 

until the 1990s. It then increased substantially, but fell back a bit during the East 

Asian economic crisis before reviving again recently. In direct bilateral Foreign Direct Investment (FDI), Japan still lags behind the U.S., Hong Kong, Taiwan, and 

the Virgin Islands (probably at least in part also an indirect source of Taiwan investment) in FDI to China,5 but China is one of Japan’s largest targets of FDI 

today. Because of extensive Japanese investment and manufacturing concerns in 

Hong Kong, Taiwan and Southeast Asia, many with business dealings with China 

as well, the actual amount of Japanese FDI, indirect and direct, is probably much 

higher than the direct bilateral figures indicate. 

In 1972 when relations between China and Japan were normalized, part of the 

agreement was that China would officially disavow any reparations claims from 

Japan for its aggression during the Pacific War. China did this in the expectation 

that Japan would consequently be quite generous in giving China Overseas Development Assistance (ODA) after normalization. Their expectations were not disappointed. Since then China has consistently been one of Japan’s two or three top 

targets of ODA. In 2001, for example, it received almost $700 million dollars (nearly 

10% of Japan’s total ODA in the world), second only to Indonesia.6 Most of this ODA 

is in the form of loans. Japan has provided a large proportion of all ODA, bilateral 

and multilateral to China. There has been a strategic intent behind Japan’s large 

ODA to China—the hope that it would encourage the further opening of China to 

trade and investment and ultimately to a more moderate and open Chinese economic and political system. 

3) The U.S.-Japan Relationship and Security: From the Chinese perspective, 

because of the U.S.-Japan alliance, their security relations with Japan are intimately tied up with the U.S.-Japan and U.S.-China relationship. In the early Cold 

War period, the Chinese government was quite critical of the U.S.-Japan alliance 

as threatening China. In the process of normalizing relations with both countries 

in the early 1970s, however, China shifted its position and clearly signaled to both 

the U.S. and Japan that it could tolerate their alliance. There were two probably 

reasons for this. First, the Chinese were more concerned at that time about ‘‘balancing’’ against the former Soviet Union whom they saw as at least as great a 

threat. Second, at least some in China have always subscribed to the ‘‘cork in the 

bottle’’ theory of U.S.-Japan relations that this relationship keeps Japan from becoming an independent military power again, and helps to keep Japanese militarism 

and aggression in check. Chinese attitudes toward the U.S.-Japan security treaty 

and alliance therefore have always been ambivalent. On the one hand, they recognize the value of the U.S.-Japan alliance for restraining Japanese independent militarism. On the other hand, the Chinese watch Japan’s military posture and expenditures carefully for signs of rapid increase portending more independent military 

might and are critical of American attempts to pressure Japan to increase these. 

And there are some in China who have seen the alliance as merely shielding quiet 

but persisting Japanese attempts to regain their independent military position—an 

‘‘eggshell’’ within which the monster is being nurtured again, rather than the ‘‘cork 

in the bottle.’’ Thus the attitude of the Chinese government toward the U.S.-Japan 

relationship has varied over time, and is dependent on Chinese leadership’s perception of the behavior of both the U.S. and Japan, and how good their relations are 

with both. 

Meanwhile, although the Japanese and American governments share similar 

goals for China and have ultimately similar interests there (a stable, peaceful, 

democratic and ultimately capitalist China open to foreign trade and investment), 

they have often differed in their views of the best means to achieve these goals and 

interests. For most of the postwar period until the mid-1990s, the Japanese government was much more sanguine about the threat of China, its steps toward democracy, its human rights record, and its closed economic system than were American 

leaders. The Japanese public was far more positive toward China, often in the (not 

very rational) belief that ‘‘same blood, same script,’’ i.e., common race and culture, 

meant that Japanese understood China better than Americans. Secure in the protection of the U.S.-Japan military alliance and with its limited military capability, JapVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00184 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
179 

7See for example, Mike M. Mochizuki, ‘‘Terms of Engagement: The U.S.-Japan Alliance and 

the Rise of China,’’ in Ellis S. KraU.S.s and T.J. Pempel, eds., Beyond Bilateralism: U.S.-Japan 

Relations in the New Asia-Pacific. (Stanford: Stanford University Press, 2003), pp. 96–99. 8 ASEAN-Japan Centre Web site, Table I–11 ‘‘Number of Foreign Residents Registered in 

Japan,’’ http://www.asean.or.jp/general/statistics/01basic/11.html. 

anese government officials believed that the best and most effective way to encourage China to become more open and democratic as well as capitalist was to use economic aid, trade, and investment. They preferred these methods over containment 

through military power, or overt pressure to remove barriers to foreign trade and 

investment or to improve China’s performance on human rights . Indeed, Japan was 

one of the last countries to impose economic sanctions on China-and many believe 

did so only because of U.S. and European pressure-and one of the first to remove 

them after the Tiananmen incident in 1989.7

4) Territorial issues, especially Taiwan: The ultimate issue of conflict in the 

relations of both Japan and the U.S. with China, of course, is the status of Taiwan. 

There is no issue more likely to enrage the Chinese people, to provoke the Chinese 

government, or to tempt China to consider military action, than an attempt to deny 

Chinese sovereignty over Taiwan, or for Taiwan to assert its independence and be 

backed in that effort by the U.S. or Japan. Fortunately, neither the Japanese nor 

the American government wishes this to happen and have supported the ‘‘one 

China’’ policy. They have further discouraged any movement toward Taiwan asserting its independence, even though there are those in the Japanese political elite, as 

in the American, who are more supportive of Taiwan than China on this issue. 

The key issue here has always been the role of the U.S.-Japan Security Treaty 

in protecting Taiwan from any attack by China, whatever the provocation. In 1969, 

the Joint Communique ́ between Prime Minister Sato and President Nixon included 

a phrase that implied that peace and security around Taiwan was essential to Japanese security. It also implied that the security treaty might bring in Japan to defend 

Taiwan in case of attack by China or at least allow the U.S. to use its Japan bases 

to repel such an attack. Given the importance of Taiwan and the sea lanes around 

it to Japanese economic and strategic interests in the region, Japan of course views 

stability in that area as of importance, but it has always been unclear whether the 

Japanese public would be willing to risk war with China over Taiwan. 

Changing Japan-China Relations: mid-1990s to the Present 

Profound changes have occurred since the mid-1990s on each of the dimensions 

briefly described above. Two trends in particular account for many of the changes 

now occurring: China’s continued growth as an economic and military power in the 

region and the continuing reaffirmation of the U.S.-Japan alliance and Japan drawing closer to the U.S. on security matters. These have both stimulated and been 

manifested in shifts in public and elite opinion and Japanese policy toward China, 

and changing Chinese behavior toward Japan. As many of the older concerns have 

faded, new and potentially dangerous ones have replaced them. 

1) Recent Changes—Public Attitudes and Historical Memories: Increasingly, 

the Japanese public has turned more ambivalent about China. In the preceding period, it was far more sanguine about its ability to manage and handle its relationship with China and China’s potential economic and military threat to it. During 

the past decade or so it has turned decidedly less confident on this score. The 

public’s favorable attitude toward China dropped precipitously after the Tiananmen 

Square incident in 1989 (see Figure in the Appendix). Even after the Japanese government reinstated aid to China after the incident and time has diminished the impact of the Tiananmen events, public attitudes never recovered because of a continuing series of events and incidents that have been received negatively by Japanese. Among these events were China’s continuing nuclear weapons tests (1995), the 

Taiwan Straits Crisis (1996), China’s reactions to Japan’s increasingly close security 

relationship with the U.S., an awkward visit by President Jiang Zemin with controversy over the historical memories issue (1998), and territorial disputes over disputed islands in the Pacific. Some of these will be dealt with in more detail below. 

In general, the Japanese public, politicians, and officials have become far less patient and deferent toward China over its playing of the ‘‘history card’’ so frequently. 

New generations are often either partially ignorant of or feel less guilty about the 

human consequences of Japan’s aggression in China during the Pacific War, and are 

tired of hearing constantly about their country’s crimes in China from the Chinese. 

Further, there has recently been an influx of Chinese immigrants into Japan. Japan 

had only about 75,000 Chinese registered foreign residents in 1985. By 2001 those 

numbers had grown five-fold to 381,000.8 The Japanese police and media often assoVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00185 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
180 

9 Yumiko Hara and Takehiro Shioda, ‘‘Images of the Other Country and Media Coverage,’’ Tables 15 and 17. 

ciate a growing crime rate in Japan with these Chinese foreign residents, and with 

the activities of Chinese gangs operating in Japan. Many people in Japan today are 

more likely to be concerned about the social problems, rightly or wrongly that they 

perceive to be associated with Chinese in their country than by anything their parents or grandparents may have done to China 60-70 years ago. The growing disparity between the Chinese and Japanese publics’ views on this issue are shown by 

the fact that among Chinese the ‘‘Discrepancy in awareness of historical facts of the 

Japanese invasion of China’’ ranks as the most serious issue in Japan-China relations and the second most important issue remaining to be settled between China 

and Japan. It ranks, however, as only the third most serious issue and sixth most 

important issue to be settled among Japanese, with twice or more as many Chinese 

as Japanese selecting this issue in each case.9

Also, Japanese government has taken a more nationalist line toward the issue, 

in part because of growing right-wing influence and opinion that has never accepted 

the historical facts of Japan’s aggression in China. Even Japanese Cabinet ministers 

and other prominent politicians have made outrageous statements denying or minimizing Japan’s atrocities in China during the war. The contrast with Germany is 

instructive: whereas in Germany it is illegal for a person to deny the holocaust and 

it is unthinkable that a German member of the government would do so, the equivalent utterances are regularly made by prominent Japanese politicians. Japanese 

prime ministers add insult to injury in the eyes of the Chinese by persisting in annual (semi-private; semi-official) visits to Yasukuni Shrine, a Shinto Shrine in Tokyo 

where the souls of Japan’s war dead are enshrined, including, and this is the most 

controversial part of this issue, the seven war criminals executed by the American 

Occupation for war crimes. China and South Korea inevitably protest these visits 

and see the refusal of Japan’s leaders’ to desist from such behavior as evidence of 

Japan’s continuing and growing nationalism, potential militarism, and 

unreconstructed lack of guilt for its wartime behavior toward those countries. Although the Foreign Ministry itself is usually embarrassed by these types of incidents and understands how they complicate their foreign relations with China, Japan’s foreign policy toward China has also become less deferential and more assertive on the historical issue. 

Nothing illustrates this better than the visit of President Jiang Zemin to Japan 

for a summit meeting with then-Prime Minister Obuchi. Japan had recently provided a written apology to President Kim Daejung of South Korea for its treatment 

of Korea, and undoubtedly President Jiang was expecting the same. He did not receive that written apology, however, in party because of opposition from conservative elements within the ruling party. In return, he brought up Japanese aggression toward China constantly while in Tokyo, further alienating Japanese elites and 

public opinion. 

A constructive consequence of this unfortunate incident has been that Chinese 

leaders now seem to recognize that insistence on playing the ‘‘history card’’ at every 

opportunity has become counterproductive and has diminishing returns. In the last 

few years, other than protests over Yasukuni visits, one hears less about the wartime memories issues from Chinese officials. 

2) Recent Changes—Economic Rivalry: Japanese economic relations with 

China moves ahead as before, but there has been a subtle shift in perception among 

Japanese political and economic elites and public about the positive consequences 

of such deep relations. In the past such relations were seen primarily as an opportunity—for Japanese business as well as to help develop China to become a more 

open nation politically and economically. They now are increasingly also coming to 

be seen as a threat. 

One reason for this is China’s increasing proficiency at exports, both their usual 

agricultural products but also now machinery and equipment. Indeed, it is said that 

Japan’s Ministry of Economics, Trade, and Industry has sometimes been shocked at 

the efficiency of China’s manufacturing factories, some of which now rival or may 

even surpass Japan’s vaunted manufacturing prowess. Increasingly, although Japanese firms including small and medium enterprise, are now manufacturing more 

and more of their products in China, among some Japanese there is not only fear 

of this ‘‘hollowing out’’ Japanese domestic industry production leading to exporting 

of jobs, but also that China will increasingly become a competitor to Japan as it goes 

up the ladder to higher and higher value-added manufacturing products. There is 

a growing feeling among Japanese business and government elites that Japan must 

run faster to stay ahead of China, unlike in the 1960–1980s when its goal was to 

181 

10See Yoichi Funabashi, Alliance Adrift. New York: Council on Foreign Relations, 1999. 

‘‘catch up with the West.’’ Ironically, Japan is beginning to experience the same type 

of competitiveness stimulus that the U.S. did from Japan during the earlier period. 

Indeed, Japan and China have experienced their first major issues over textiles 

and agricultural goods. From 1994 to the present, Japanese textile manufacturers 

who have lost market share increasingly to Chinese imports, have been trying to 

get the Japanese government to impose ‘‘safeguard’’ measures on some categories 

of Chinese textile products. The government thus far has continually postponed 

doing so. This response has been made easier by the fact that a significant percentage of Japanese companies also import textile goods from China and the Chinese 

government has been cooperative in trying to voluntarily restrain some exports. 

Agriculture, however, has been a different story. Japanese agriculture, as is wellknown, is highly protected for political reasons. Rural districts essentially are overrepresented in Japan’s parliament (the National Diet) and strongly support the ruling Liberal Democratic Party (LDP). It is no exaggeration to say that these 

malapportioned districts have kept the LDP in power for almost all of the last halfcentury. In 2001, a full-scale ‘‘trade war’’ broke out over China’s increasingly successful expansion exports of categories of vegetables and other agricultural productions. On April 17, 2001, under pressure from the farm lobby, the Japanese government decided to impose provisional safeguard curbs on imports of welsh onions, 

shiitake mushrooms and tatami (straw mat) rushes. These products were grown in 

a region where influential LDP politicians in agriculture had their constituencies, 

and the party was also feeling vulnerable because its prime minister (Mori) was unpopular and an upper house election was approaching. The government at first tried 

to resolve this by getting the Chinese government to adopt voluntary export restraints, but the latter refused. Japan then imposed ‘‘safeguard measures’’ to limit 

imports of these products. China immediately retaliated by levying a 100% special 

duty on imports of Japanese motor vehicles, mobile phones and air conditioners, important and valuable Japanese exports to China. 

The crisis was settled in Dec. 2001, when Tokyo agreed not to enforce full scale 

import curbs on agricultural products from China, and Beijing lifted its retaliatory 

duties on Japanese products, with both sides agreeing to establish a consultative 

organ of industry organizations to discuss agricultural product trade. Nevertheless, 

these two cases are undoubtedly only the opening rounds of continuing trade friction 

between the two countries in the future, given China’s increasing competitiveness 

in several sectors in which Japanese industry is declining or which are political sensitive, such as agriculture. If current trends continue, we may also expect Chinese 

industry to begin to challenge Japan in some of its traditionally strong sectors, 

much as South Korean firms are now doing in semiconductors and electronics. We 

may also expect each of the two countries to use the WTO to both challenge the 

other on some issues but also to try to settle their future disputes now that China 

has become a member. 

China’s economic growth and actual and potential challenge to Japanese industry 

in some sectors has also led many Japanese taxpayers to question why their government continues to provide ODA to China as if it were still an undeveloped nation. 

Political pressure has led the government to begin to scale back some of its assistance to China for the first time in the postwar period. 

Finally, Japan and China are becoming increasing rivals for trade with ASEAN 

and other Asian countries. China proposed a Free Trade Agreement (FTA) with 

ASEAN that was initially rejected but ultimately accepted with negotiations under 

way, and Japan has now proposed the same to ASEAN. Singapore has signed an 

FTA with Japan and has now in the latter part of 2003 proposed the same to China. 

Much as with the U.S.-Japan trade friction and competition of the 1980s–1990s, 

economic integration and interdependence has not prevented Japan and China from 

also to some extent experiencing trade disputes and economic rivalry. 

3) Recent Changes—The U.S.-Japan Relationship and Security: In no dimension has the China-Japan relationship shifted more dramatically, however, than 

in the area of security. After the U.S.-Japan alliance began to ‘‘drift’’ 10 at the end 

of the Cold War, policymakers on both sides of the Pacific intervened to ‘‘reaffirm’’ 

the importance of the alliance. Meanwhile, the Taiwan Straits Crisis of 1996 and 

North Korean’s firing a test missile over Japan in 1998 fundamentally shifted public 

and elite opinion in Japan. Previously, both had been comfortably secure that the 

U.S.-Japan alliance would provide the security and protection Japan needed. Now, 

with the alliance seeming to unravel and the North Pacific environment, including 

China’s increasing economic and military power, seeming to become more unstable, 

both countries shored up their security relationship. Fundamental changes in Japan’s domestic political situation also facilitated the change, particularly the rapid 

182 

11The experience of Japan’s sending a unit of its Self-Defense Forces to Iraq might also provide a clue. As in many countries in Europe, a large majority of public opinion was against the 

American invasion of Iraq. If casualties to their SDF unit occur, the reaction of the public-acceptance with equanimity or severe reaction against continuing their dispatch-would provide 

decline of the leftist parties that had thoroughly opposed greater Japanese military 

build-up and a closer security relationship with the U.S. 

The reaffirmation of the alliance was accomplished both symbolically in the Clinton-Hashimoto Summit Joint U.S.-Japan Declaration and more practically by new 

Japanese defense adjustments such as the National Defense Program Outline 

[NDPO, 1996], and negotiated arrangements for the implementation of the Security 

Treaty—their first revision in almost twenty years (Guidelines for Japan-U.S. Defense Cooperation, 1996). The latter were passed by the Diet and seemed to shift 

the emphasis of the Treaty from the defense of Japan (Article 5) to regional stability 

(Article 6). Japan already had an increasingly sophisticated Maritime Self-Defense 

Forces (navy) of 80 major warships, including Aegis destroyers—probably the third 

most impressive in the Asia Pacific after the U.S. and Russia—although China’s is 

larger, it is not as modern. These measures to strengthen the U.S.-Japan alliance 

have raised concerns among some in China that the alliance is moving toward the 

goal of ‘‘containment’’ of China and that the ‘‘eggshell’’ theory of the alliance providing for the nurturance of a remilitarized and threatening Japan may be a more 

viable interpretation than the ‘‘cork in the bottle’’ restraining of potential Japanese 

aggression. 

Perhaps China’s most concrete concern is the joint development of ‘‘Theater Missile Defense’’ (TMD) by Japan and the U.S. Not only does this program seem to lock 

Japan and the U.S. into an inextricable technological embrace that might be aimed 

against China but also has implications for the status of Taiwan (see below). 

Nevertheless, the North Korean nuclear crisis has placed China into a pivotal role 

vis-a`-vis both the U.S. and Japan. China is the major country that may have some 

influence on North Korea. and therefore is crucial to any settlement of the status 

of North Korea’s weapons of mass destruction. China is now the key mediator and 

player in the 6-party talks still ongoing to help resolve the nuclear issue. However, 

Japan also may require China’s mediating role on another issue with the North Koreans because of the ‘‘abduction’’ North Korean agents of several Japanese citizens 

over the years with some, or their children, still held there. Japan very much wants 

an accounting of the fate of its citizens, and quite naturally considers their abduction a serious human rights issue. The Japanese media and public opinion are quite 

focused on their return or at least confirmation of whether and which among them 

are still alive. Further, China raised no objection to Japan’s dispatch of destroyers 

(originally conventional, but now including Aegis) to the Indian Ocean to aid the 

U.S. campaign against the Taliban in Afghanistan. These actions or non-actions on 

China’s part hopefully may help to reassure Japan that China is committed to a responsible regional role in the future. 

4) Recent Changes—Territorial Disputes: Japan’s much closer security relationship with the U.S. has raised a particular concern in China over the future of 

Taiwan. Although the 1969 Sato-Nixon Communique ́ seemed to apply the U.S.- 

Japan Security Treaty to Taiwan, this issue has laid dormant since. However, in 

the legislation surrounding the new Guidelines for the Treaty passed by the Diet, 

the phrase defense cooperation in ‘‘areas surrounding Japan’’ appears. China became immediately concerned that this was a clear application of the Treaty to the 

defense of Taiwan and that Japan was now implementing the Sato-Nixon 

Communique ́ in specific ways. Japan’s response was to intentionally obfuscate rather than clarify the meaning of this phrase. The official Japanese government position is that ‘‘areas surrounding Japan’’ is not a firm geographic designation but 

rather one that will be decided depending on the extent to which and how the circumstances threaten Japanese security. This policy is designed both not to encourage China to take over Taiwan by force by clarifying that it does not apply to Taiwan, but also to try to deter such Chinese behavior by not ruling out the possibility 

that Japan might be committed to the defense of Taiwan under some circumstances. 

Combined with TMD’s potential application to the defense of Taiwan, these matters 

are of increasing concern to the Chinese government. Whether such vagueness ultimately will prove functional in these regards, or rather only add to Chinese fears 

that the U.S.-Japan alliance is now squarely aimed at China and a threat to its security, and thus be de-stabilizing for the region, remains to be seen. Further, it is 

also not clear whether, even if Japan’s foreign policy elites are privately committed 

to Taiwan’s defense, the Japanese public is willing to risk a war with China over 

Taiwan. Much would probably depend on the circumstances of an attack on Taiwan, 

particularly if it appeared unprovoked or not.11

183 

some indication of the public’s willingness to sustain sacrifice for the alliance outside of Japan’s 

defense. 

Taiwan, however, is now not the only heightened territorial issue between China 

and Japan. There are also territorial disputes between China and Japan over the 

Senkaku/Diaoyudao Islands in the East China Sea. Nationalist elements in both 

countries have staged incidents in the 1990s that inflamed the dispute, either with 

the encouragement of both governments or at least their winking at them rather 

than acting to prevent them. Nevertheless, despite occasionally catering to nationalist elements and opinion, both China and Japan have tried to decrease tensions 

over this dispute and thus far have managed to do so. The U.S. is in a particularly 

difficult situation regarding this dispute because while it insists that it takes no 

sides in the sovereignty issue, it also has included the islands in the reversion of 

Okinawa to Japanese administration in 1972. Japan and China, as well as other 

countries, also dispute the East China Sea continental shelf boundaries and their 

economic zones. Here the stakes are higher than the Senkaku dispute because there 

are oil and gas exploration possibilities in this area. There have been several incidents where incursions of Chinese vessels into waters claimed by Japan have occurred, and occasionally Japanese reaction, but so far both countries have avoided 

either solving the issue or exacerbating it beyond the level of present irritation. 

Implications and Dilemmas for U.S. 

There are several ironies of the present situation in East Asia. One is that while 

during the Cold War the U.S. attempted to ‘‘balance’’ two potential enemies, China 

and the former Soviet Union, in order to preserve stability in the region. In the 

post-Cold War period, the U.S. may increasingly be forced into situations where it 

must ‘‘balance’’ two potentially friendly nations with whom it has extensive economic ties, one an ally and the other very possibly the future most powerful Asian 

state, while preventing a China-Japan arms race and conflict that would destabilize 

the entire region. Another irony is that when China was a relatively radical and 

isolated country, the Japanese public and elites were sanguine about its threat to 

Japan; but now that China is moderating its foreign policy behavior, seeming to try 

to become a responsible member of the international community, and attempting to 

dampen tensions with Japan, Japan is perceiving China as a possible increasing 

threat. 

The increasing potential for conflict in the China-Japan relationship because of 

perceived security threats on both sides, the continuing lack of resolution of the historical memories issue, increasing economic rivalry and trade friction, and the exacerbated territorial issues including Taiwan, all pose major policy dilemmas for the 

U.S. I can only raise these issues here in the hope that sensitivity to them among 

policymakers in Washington will aid in finding eventual ways to efficaciously manage them: 

—How can the U.S. maintain its crucial security alliance with Japan while avoiding the ‘‘security dilemma’’ with China, whereby measures taken under the alliance designed for defensive and stability goals are not misinterpreted by Chinese elites as threatening, especially given their continuing suspicions that the 

U.S.-Japan alliance may be an ’eggshell‘‘ nurturing Japanese militarism? 

—How can the U.S. send clear signals to China about Taiwan not being taken 

over by force and hope for Japan’s cooperation in event of crisis, without necessarily relying on the latter or exacerbating China’s suspicions about the alliance? To what extent can the U.S. trust that Japanese public opinion is willing 

to risk war with China over the defense of Taiwan in the case of a crisis? 

—How can the U.S. compete against Japan in the China market and foster Chinese economic growth, even while discouraging too much economic rivalry or 

disastrous trade disputes that might inflame tensions between the two countries? 

—How can the U.S. not get involved in the two countries territorial disputes and 

promote peaceful settlements of these issues without offending either? 

The peace, security, prosperity, and prestige of the U.S. and the Asia-Pacific depend on our finding effective answers to these dilemmas created by the Japan-China 

relationship. 

184 

APPENDIX 

Source: Figure reproduced from Tsuneo Watanabe, ‘‘Changing Japanese Views of China: A 

New Generation Moves Toward Realism and Nationalism’’ in Carolyn W. Pumphrey eds. ‘‘The 

Rise of China in Asia: Security Implications’’ published by Strategic Studies Institute, U.S. 

Army War College, January 2002). 

Chairman ROBINSON. Well, thank you very much for that fascinating component which the Commission is most interested in 

and has not heard enough of, namely, the Japan-China relationship 

and its implications. And you can be sure that you’ll be—there will 

be questions on this. I would like to now turn to Dr. David 

Lampton, who is professor of Chinese and East Asian Studies at 

the School of Advanced International Studies at Johns Hopkins 

University. Delighted you could be with us, and we look forward 

to your remarks. 

STATEMENT OF DAVID M. LAMPTON, Ph.D. 

PROFESSOR OF CHINESE AND EAST ASIAN STUDIES 

SCHOOL OF ADVANCE INTERNATIONAL STUDIES 

JOHNS HOPKINS UNIVERSITY 

Dr. LAMPTON. Well, thank you, Mr. Chairman and Commissioners. Good to be with you. Good to be back in the state in which 

I was born, although I’ve lived more of my life outside the state. 

I left this state 30 years ago, and the Silicon Valley, where I grew 

up, was just apricot orchards. And there were two guys working in 

a garage at that time, Hewlett and Packard—literally a garage. 

And those developments not only transformed this state, but 

really transformed the world. What you heard yesterday was a reflection of what’s possible when you have the correct combination 

of government policy, innovative people working, and education 

and so on. 


Insert krauss12.eps
185 

Yesterday what was referred to as ‘‘the San Diego’’ line is actually, I think, the crystallization of the experience this state’s had. 

And I think it’s an excellent departure point for U.S. policy. 

Every part of the country, this complex country, has its own 

problems. But what we heard yesterday was a whole lot more than 

the San Diego line. I think it was a guidepost for where we should 

go. 

I have been asked to talk about Chinese power and what it 

means for the United States. And my testimony and my written remarks will be compatible, but not identical. 

Listening to yesterday I came away with two takeaways. Yesterday’s testimony and the questions and interaction were really the 

best public education program I’ve heard in a long time. 

My two takeaways from that are. One is that security is not just 

about identifying threats, although we all know about that. It’s also 

about seizing opportunities faster than the other guy. That’s been 

our comparative advantage and it is where we ought to move. A 

second takeaway was that we have an opportunity, as Dean 

Cowhey said, to build a ‘‘Pacific Community.’’ And this isn’t just 

nairy-fairy, sort of a community ethic and spirit. It’s really the only 

way we are going to stay competitive in an economic and cultural 

sense. So I think yesterday was a very important day. Now, I 

would like to make three points on China’s power and what it 

means for the United States: 

First of all, China is getting stronger. And power isn’t just undifferentiated; there are at least three kinds of power. I want to talk 

just briefly about those three kinds of power and how China is getting stronger in each. 

Secondly, there is no doubt that this is going to require of the 

United States some adjustments. Some will be much more painful 

than others. And there will be some genuine threat, as well as opportunity, in this growth of Chinese power in a comprehensive 

sense. 

But, finally, the potential gains that we face from the growth of 

Chinese power are much greater than the potential problems, if we 

play our cards right. I see more opportunity in the growth of Chinese power than worries if we have the correct mix of policy. What 

kinds of power do I mean? 

I mean essentially guns, money, and ideas. Sociologists call it remunerative power for money, coercive for guns, and normative for 

ideas. But those are essentially the three kinds of power. And 

China is getting more powerful along each of those dimensions. 

If you look at the bilateral trade statistics in Asia, China is becoming the major purchaser of what more and more countries in 

Asia are selling. You look at the percent of each Asian country’s exports going to China, and almost uniformly it’s going up. In 2002, 

for Taiwan and the Republic of Korea, China became the largest 

market for each of those economies. And they’re at the cutting edge 

of that development. China is becoming the biggest buyer of what 

Asia has to sell, or a bigger and bigger buyer. 

Everybody who’s ever been in business knows that when you 

have something you want to sell to somebody, your buyer becomes 

a very important person or entity in your life. China’s becoming 

more powerful because it’s buying more and more of what people 

186 

in Asia have to sell. You can see this money power in other dimensions. 

China’s the No. 2 holder of U.S. Treasury notes. I met with the 

former Minister of Finance, Xiang Huaicheng, some time ago over 

breakfast. 

He said, Professor Lampton, all this about Treasury notes, it’s all 

perfectly true. But we also hold corporate paper. We hold municipal 

paper. We hold state paper. The debt that China holds of the 

United States is much bigger than just Treasury notes. If you look 

at another form of money power, China’s becoming a major investor 

in Asia. Chinese FDI in ASEAN last year—or in 2002, the last year 

for which we have full figures, went up 60 percent. So the notion 

that Chinese power is just us investing in them is only part of the 

story. China is investing, particularly in natural resources all over 

the world, including Southeast Asia. 

Turn to military power. I won’t spend much time here because 

I know other hearings have addressed this subject. But China’s defense budget is going up at a pretty good clip, although lower last 

year than in the past, but still pretty high. 

If you look at other activities China’s undertaking in the military 

area, it’s now cooperating in joint military exercises with Pakistan, 

India, Kyrgyzstan, Kazakhstan. 

So China’s military is reaching out and I think largely for cooperative reasons in the region and indeed beyond. 

-Turning to normative power, we’re not very used to thinking 

about the Chinese as having idea power. But, in fact, they are 

gaining here in a number of ways. Just let me give you one figure 

on that. We’ve always thought that the big attraction America had 

was bringing students from around the world to universities such 

as the University of California at San Diego. That’s absolutely true. 

China now is beginning to draw students from all over Asia. At Peking University alone there are 3,000 foreign students, 800 of 

whom are from South Korea. China’s development model of stability, of rapid growth is attractive throughout much of the world. 

The United States is not the only nation with ideas that are proving attractive. 

Now, this growing power—whether it’s idea power, military 

power, economic power—is going to require some very important 

adjustments in U.S. policy and thinking. It’s going to have a number of effects. 

First of all, just look at the effect on the Republic of Korea-U.S.- 

Alliance. The long and the short of it is that since 1992, Korea has 

developed important economic and security relations with China. 

And you will find right now that the South Koreans often,—particularly with respect to Korean peninsula issues, find themselves 

agreeing with the Chinese more than us, and this is one of our allies! 

If you look at Deputy Secretary Armitage’s visit to Australia in 

early 2002, he raised the issue of a Taiwan conflict scenario. And 

if there was conflict, he indicated that we expected the Australians 

to be with us. 

There were a lot of Australians that questioned that assumption 

very publicly. So China’s power is going to have implications for 

our alliances. 

187 

Certainly another impact will be on the utility of economic sanctions in U.S. policy. I would just call your attention to page 5 of 

my written testimony. I think I put it pretty succinctly. 

Sanctions are going to be of declining utility when you recognize 

China is only part of a very long production chain. As I put it, if 

on a given $1 item produced in China and intended for export to 

the United States, China’s value added is 15 cents per dollar, $1 

of U.S. sanctions directed at this product will inflict 85 cents of 

pain on Washington’s other friends. 

Using such a policy instrument too frequently is both bad economics and bad politics. In short, because China is now so integral 

to the global production and supply chain, we are not going to be 

able to just target our punitive economic measures at China. It’s 

going to hit all of our friends starting with Taiwan and Hong Kong 

and working throughout Asia. 

o the long and the short of it is that the rise of Chinese power 

is going to affect the kinds of tools that we can use. 

I think it’s also going to force us, as Dr. Shirk said, in a more 

multilateral direction. 

The -Six-Party Talks that are going on and off with uncertain results is indicative of where China’s pushing. It’s pushing for more 

cooperative security arrangements. And, it remains to be seen what 

the ultimate effect of rising Chinese power is going to be on our 

alliance with Japan and Korea. We’re going to have to think about 

providing security in a much more multilateral way. 

Rising Chinese power is also going to make our friends throughout Asia less responsive to a lot of the calls we make. 

A couple of weeks ago there was a lot of talk in Washington 

about calling for revaluation of the Chinese currency. You’ll note 

many people in Taiwan didn’t even support that kind of policy. 

So the long and the short of it is that we have problems and 

challenges. But, where are the opportunities? 

I think a strong China is going to be more helpful to us in solving some of the security problems we have. North Korea is a good 

example. A poor China, if you think about that, isn’t going to have 

the middle class that’s going to develop hopefully in a more democratic direction. Certainly a poor China isn’t going to buy much of 

what the United States has to sell. 

And, finally, a poor China isn’t going to be very helpful to us in 

security in Asia. The China we see now is inclined to help us with 

respect to Pakistan and on things like the Container Security Initiative and so on. 

So, China’s getting stronger, that presents problems, but I would 

much prefer the gains that I see coming from a strong China than 

fear the downsides, if we play our cards right. 

[The statement follows:] 

188 

Prepared Statement of David M. Lampton, Ph.D. 

Professor of Chinese and East Asian Studies 

School of Advanced International Studies, Johns Hopkins University 

China’s Growing Power and Influence in Asia: Implications for U.S. Policy 

China’s Influence Is Growing: 

There have been six post-9/11 alterations in the regional and global security environments most significant for American interests and the prospects for continued 

U.S.-China cooperation, security and otherwise: 

• China’s economic and diplomatic clout in Asia has dramatically increased since 

1997, in the context of a Washington preoccupied elsewhere and a less economically potent Japan. China’s increased power is reflected in the realms of economic power (remunerative), military power (coercive), and even ideas (normative), with the increase in economic influence being most dramatic. Further, 

in its diplomatic strategy in the region and the world beyond China is leading 

with its economic power, placing less emphasis on military power, with Taiwan 

being the principal exception in this regard. Nonetheless, American preeminence in Asia remains the central geopolitical and economic fact, a circumstance reflected in the PRC’s priority on maintaining productive relations 

with Washington. 

• North Korean nuclear weapons programs have fostered Sino-American cooperation to a degree few would have predicted in November 2002, simultaneously 

strengthened U.S. cooperation with Japan, and have had the opposite effect 

with respect to Seoul-Washington ties. China’s diplomatic heft has gone up by 

virtue of its efforts to broker a non-disruptive resolution of the crisis. 

• Japan gradually is assuming more responsibility for its own defense and beginning to provide limited ‘‘global, public security goods,’’ a development that is occurring with American blessings and Chinese wariness. Simultaneously, Japan 

is developing ever-deeper economic ties with the PRC and Beijing is not making 

an issue of Tokyo’s changing security role, though it is worried. The U.S.-Japan 

alliance is strong, in part as a hedge against a rising China, and, Chinese leaders have partially conceded that the U.S.-Japan alliance has given Beijing a 

‘‘free ride’’ on security. The net is that China seems reconciled to a more ‘‘normal’’ Japan and the U.S.-Japan Security Alliance as long as neither are aimed 

at promoting the separation of Taiwan or containing China, concerns that never 

will be fully assuaged in Beijing. 

• South Korean-Chinese economic (and to a lesser extent security) relations have 

grown with remarkable speed since the two nations established diplomatic ties 

in 1992. Today, Beijing and Seoul often have been closer on inter-Korean Peninsula issues than Washington and Seoul. The ROK-US alliance relationship is 

troubled, raising the issue of its long-term prospects. 

• The War on Terror (here to include the war in Iraq and counter-proliferation 

policy) has fostered growing and important Sino-American cooperation. Cooperation in this domain has reduced some of the vigor with which Washington’s demands on China in some other domains (economic and civil rights) are pursued. 

Beijing was (and remains) very helpful in the War on Terror and it served minimal American interests by getting out of the way with respect to Iraq. 

• With respect to Taiwan, the core friction in U.S.-China relations since 1950, 

micro-nationalism and competitive electoral politics have energized Taipei’s increasing efforts to assert autonomy. This threatens Beijing’s and Washington’s 

interests to the extent that a conflict in the Strait could ensue that neither capital desires. For now, this has produced Sino-American cooperation (perhaps 

limited and temporary) and generated growing friction between Washington and 

Taipei. American allies and friends increasingly are allergic to a Taiwan Strait 

conflict and Tokyo and Paris have urged restraint on Taipei in the run up to 

the March 2004 presidential elections, as did President Bush on December 9, 

2003. 

Cumulatively, the developments highlighted above reflect the comprehensive 

growth of Chinese power in the realm of money, coercive force, and ideas. What are 

the implications of China’s rise for American interests, broadly defined? 

Implications for the United States: 

It is inaccurate to say that Asia has become Sinocentric. The economic and military power of America remains a central geopolitical and economic fact for every nation on the PRC’s periphery. Moreover, China is not yet a balanced comprehensive 

power; its coercive and normative power still weak compared to its growing ecoVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00194 Fmt 6633 Sfmt 6621 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
189 

nomic muscle. Also, China’s influence remains uneven around its circumferencestrongest on the Korean Peninsula, weakest (but growing) in Central Asia, and 

growing briskly throughout East and Southeast Asia. Moreover, it is fashionable, 

but mistaken, to ignore Japan’s current power and future potential because of its 

protracted national malaise. And finally, at the same time that the PRC’s neighbors 

seek to gain from enhanced Chinese capabilities, they also seek more distant balancers to hedge against Beijing’s power. 

While neither the United States nor others ought to overreact to China’s increased power and influence, the success of Chinese policy does have implications 

for America. The most important of these implications is that the principal directions in which Chinese policy has moved (toward the use of remunerative and normative instruments, and away from coercive power [except with respect to Taiwan]) 

are consistent with fundamental U.S. interests. Washington ought not deflect China 

from its basic heading. Nonetheless, rising Chinese power requires some adjustments, and perhaps profound changes, both in U.S. policies of long-standing and 

those of more recent vintage. China’s rise has implications for regional alliance and 

security structures, the kinds and mixes of power America exerts in the region, and 

Washington’s ability to use sanctions and other instruments of policy. 

A key point is that Washington’s post-9/11 mix of power, in the eyes of many 

throughout Asia, has overemphasized military strength and takes insufficient advantage of America’s economic and potential normative muscle. Normatively, the 

United States now is less attractive throughout Asia than it has been in the past, 

if almost any public opinion survey is to be believed. Washington has become too 

distracted. Americans need to do more listening throughout the region. Finally, 

Washington needs to place more emphasis on multilateral security and economic relationships. As well, the difficulties visa issuance are creating to economic and cultural exchange are a serious impediment to the effective employment of American 

economic and normative power. 

With respect to the realm of coercive power, perhaps the most dramatic consequence of China’s rise has been the weakening of the U.S.-South Korea Alliance 

and the longer-term effects that China’s growing strength may have on Washington’s other regional alliances. While growing Chinese military power may strengthen the perceived need in Japan, the Philippines, and perhaps Australia for alliance 

with Washington, the PRC’s growing economic attraction and its currently benign 

foreign policy may simultaneously lessen the perceived need for these pacts. Which 

of these contending forces prevails (the China threat or China’s attractiveness) will 

depend greatly on how both Beijing and Washington play their cards in the future. 

Thus far, Beijing has played them skillfully. 

In the case of South Korea, the strains in the U.S.-ROK Alliance already are everywhere apparent. Beijing’s economic attraction to Seoul, China’s greater leverage 

over North Korea than any other outside power, and a U.S. policy toward 

Pyongyang that worries South Koreans cumulatively have put China in the catbird 

seat. While it is far too early to pronounce the death of the U.S.-ROK Alliance, restoring its vitality is going to require changes. In the more distant future, Washington may have to consider whether a new security framework (perhaps involving 

the six parties in Northeast Asia) is needed to replace or supplement the traditional 

bilateral alliances in the region. 

Turning to the Taiwan Strait, this is the one issue that, if mismanaged (by Taipei, 

Beijing, and/or Washington), could produce a dramatic increase in the acquisition 

and use of Chinese coercive power. The many deficiencies of Beijing’s policies toward 

Taipei, combined with micro-nationalism on the island, create recurrent pressures 

on Taiwan to assert autonomy in ways that are dangerous. Washington’s policy of 

deterrence has helped restrain Beijing from either overreacting to Taipei’s actions 

or being proactively coercive. But, Washington should be no less vigilant with respect to Taipei’s actions. The ball on which Washington should keep its eye is stability and growth in the region as a whole and encouraging Beijing to remain on 

the policy trajectory described above. This likely will require U.S. administrations 

and the U.S. Congress to periodically be firm with Taipei. President George W. 

Bush’s December 9, 2003 statement in front of visiting Chinese Premier Wen Jiabao 

(‘‘The comments and actions made by the leader of Taiwan indicate that he may be 

willing to make decisions unilaterally to change the status quo, which we oppose.’’) 

is an example of what periodically may be required. 

Even more fundamentally, as more and more American allies and friends in the 

region develop positive stakes with the PRC, how supportive are they likely to be 

of an American intervention in the Taiwan Strait? When Deputy Secretary of State 

Armitage went to Australia in early 2002 and suggested that Washington expected 

Canberra to be at its side in a Taiwan contingency, former Australian Prime Minister Malcolm Fraser said: ‘‘[The Australia-New Zealand-United States Defense 

190 

Treaty] designed to achieve Australian security is now being distorted potentially 

to embroil us in a conflict of America’s choosing with another super power [China].’’ 

The PRC’s rise also has important implications for the remunerative realm of U.S. 

policy. Most fundamentally, as the PRC increasingly becomes an engine for regional 

and global economic growth, the strategic importance of stable ties between Washington and Beijing will grow beyond narrowly defined security interests. 

The fact that China is embedded deeply within key global supply chains and increasingly has become the final assembly point for products that incorporate the 

value-added components made by many of America’s friends throughout the region, 

means that Washington increasingly will discover that to economically retaliate 

against China is to economically strike America’s allies and friends. Put crudely, if 

on a given one-dollar item (produced in China and intended for export to the United 

States) China’s value-added is 15 cents per dollar, one dollar of U.S. sanctions directed at this product will inflict 85 cents of pain on Washington’s friends. Using 

such a policy instrument too frequently is both bad economics and bad international 

politics. 

U.S. multinational firms that have invested in the PRC both as an export platform and as a base from which to penetrate China’s domestic market increasingly 

will resist unilateral, punitive impulses in Washington. Moreover, the degree to 

which China recycles dollars earned in this globalized trade into the United States 

(in the form of U.S. Treasury notes and other debt instruments) means that Washington increasingly will find it difficult to punish Beijing without punishing itselfChina is the number two holder of U.S. Treasury notes after Japan. 

Further, as more and more countries become significant suppliers to China, they 

may well find that their economic interests often parallel those of the PRC. For example, when in late-2003 and 2004 many in Washington called for Beijing to revalue or float its currency, few in Asia supported the U.S. position. As Taiwan’s 

China Post put it, ‘‘So the notion of getting Beijing to relax its currency controlsan American economic priority-is hardly a top goal in this part of the planet.’’ 

Turning to the realm of normative power, the United States needs not only to pursue the war on terror and associated activities, it also must devote more economic 

and diplomatic effort to remaining a nation that attracts through the power of positive example. 

If it is to replenish its stock of soft power, the first place the United States must 

begin is by placing greater emphasis (both rhetorical and financial) on economic, social, and political development through institution building, talking more about development as a process rather than simply as an end state in which there is democracy, rule of law, and human rights. 

The developments enumerated above point to something very fundamental. China 

is becoming a more adept player in the emerging regional and global orders--America must adapt its economy and its policies to the logic of the system it has played 

a central role in creating. China’s rise could be profoundly positive for America and 

for the world system, or it could lead to friction and conceivably conflict. If positive 

outcomes are to occur, it will be because both countries responded positively to the 

opportunities for cooperation that interdependence creates. 

Panel I: Discussion, Questions and Answers 

Chairman ROBINSON. Well, thank you for that. I must say that 

these were extraordinary and certainly will frame this morning’s 

discussions. I couldn’t think of more timely division—well, topics 

for a division of labor here. 

I would like, if I might, in commencing the question period to 

take the prerogative, which I rarely do, and ask a question myself 

of Dr. Krauss. Because, as I mentioned, one thing we don’t get 

quite enough attention to is the bilateral or trilateral, as you’ve put 

it, U.S.-Japan-China relationship. 

And one thing that’s been of great interest to us is the fact that 

Japan studiously avoids using the term ‘‘China’’ as a prospective 

threat for the future, even though arguably if you look at their 

military procurements and you see new Aegis destroyers, SM3 missiles to presumably serve off of that platform as high-altitude missile defense, PAC-3 missile batteries, aerial refueling tankers in 

part for their AWACS and fighters, which are top of the line in the 

191 

case of the AWACS, and indigenously manufactured maritime patrol aircraft that is of high priority for them. 

We see that—if you look at the timetable for those procurements 

and you recognize that Japan is—finds it politically acceptable to 

focus on the North Korean crisis as a catalyst for those procurements, but when you think about when those items are really going 

to come on line, depending on your North Korean crisis scenario, 

whether it’s just going to be a containment strategy for a 

nuclearized North Korea or whether this could get far more sporty 

in the next couple of years, the North Korean event would not be, 

I think, the subject of concern that it is today in 2005, 2007, when 

these front-line systems start coming on stream, which begs the 

question, what are they for? And, of course, those of us that look 

at this from time to time would argue that China is the longerterm threat. 

Now, you’re not going to hear those words in Japan or see them 

on paper, but do you see a time when this situation too, Dr. 

Krauss, will evolve somewhat and you’ll start to see, first, elliptical 

references like the one that you mentioned about their interest in, 

quote, the surrounding areas tend to get a little more explicit over 

time? Or do you think that Japan will maintain this awkward silence on what has to be regarded, given its robust military buildup 

and its offensive quality, a China threat for the future? 

Dr. KRAUSS. That’s a good question and a complicated one. 

I must say I think you’re absolutely right. I think the situation 

of China, to some extent in the United States, although less than 

in Japan, is a little bit like all of us sitting on the couch sipping 

tea while there’s an elephant sitting right next to us. Nobody’s 

talking about it. But I think the concern over North Korea is genuine. I don’t think that that’s just a facade for a cover for doing 

what they would like to do for China. Japan was—and Japanese 

public elite was profoundly shocked by the Taepodong missile going 

over Japan. 

It so happened that the Taiwan Straits crisis and China’s emergence as a stronger military and economic power has all occurred 

simultaneously in the last decade with the North Korea threat as 

well. So it’s very hard to disentangle those. But, as you say, I have 

no doubt in my mind that the Japanese political elite, at least, is 

looking down the road to the potential threat of China, as well. 

And this may be a longer term, more subtle motivation for it to 

move closer to the United States in terms of security. 

I just want to point out the continuity to some extent in Japanese policy. And people don’t often recognize that the Yoshida Doctrine in 1951 and ’52 in which Japan separated security and economics and essentially said, ‘‘we’re going to rely on the U.S. for security and we’re going to do what’s minimally necessary to keep 

them protecting us, while at the same time we’re going to concentrate on economic growth,’’ is in many ways still the Japanese 

policy. 

Japan is much more independent or autonomous of the U.S. economically and is hedging its bets rather strongly, even while doing 

what it needs to do and even more so, in some cases, in order to 

keep the U.S. security treaty strong, and these days even stronger. 

I mean sending Self-Defense Forces to Iraq is not about sending 

192 

Self-Defense Forces to Iraq. It’s about ensuring that Japan has a 

good—a voice at the table with the United States and also keeps 

good relations with the Bush Administration when they need the 

United States in the North Korea issue. 

It’s a nested game within the North Korea issue because, frankly, the Japanese don’t care that much about Iraq. And Japanese 

opinion has been very negative on it. 

I don’t know if it will become more explicit over time. I don’t 

think so because of the economic integration with China. And it 

doesn’t serve Japan’s interests to threaten China. And the Japanese elite, despite its impatience with China over the history issue, 

is still sensitive to their feelings on this. 

So I think we may have that elephant sitting on the couch with 

us for some time. 

Chairman ROBINSON. Well, thank you very much. 

I would like to turn the microphone over to Vice Chairman 

D’Amato at this juncture. 

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

And I want to commend all three panelists for very thoughtful 

and provocative testimony. I have a few questions for Professor 

Shirk and also Professor Lampton. 

I think you’re absolutely right that there’s been a lack of attention to the region as a region. Regional diplomacy has been greatly 

lacking. The lack of institutions in the region contrasts directly 

with the tremendous successful effort we made in Europe over the 

years to build regional institutions. I also want to commend you for 

your efforts on Track 2 on North Asia. I think that’s a very, very 

important contribution to American diplomacy in the region. 

And I certainly think that we believe that a multilateral solution 

to the North Korea issue is far more attractive than bilateral diplomacy. In fact, the chairman and I have recommended to the congressional leadership a while back that the leadership consider seriously and insisting on this being treated as a treaty. The reason 

being that making it into a treaty would require a building of a 

consensus across the aisle in the Congress in the fashioning of an 

agreement that would stand the test of time, as it would normally 

do in any situation where you were able to bring the Congress on 

board. 

I think that was the great flaw in the framework agreement. The 

Congress was not brought in in a way to build bipartisan consensus. There was partisan bickering almost immediately. The ink 

wasn’t even dry on the agreement. 

And that would have been avoided had the Congress been 

brought in. It’s a very difficult thing to do that, but the rewards 

are terrific. 

So I think that multilaterally in bringing the Congress in, in an 

area where we’re talking about proliferation, the kind of problems 

that focus the country, would certainly—qualifies, I think, for treating it as a treaty. 

And, by the way, both the Japanese and South Koreans have told 

us that they would have to bring any type of multilateral agreement to their legislative bodies for approval. So they would have 

to go through the process of bringing about consensus building in 

their legislatures. I also think your proposal, your idea, which is 

193 

bureaucratically radical, but certainly intuitively, sounds very valuable—to put a high-ranking diplomatic official permanently in Hawaii. 

I actually do think that’s a very, very good idea. I certainly think 

it would be something that this Commission ought to consider recommending in terms of its report to the Congress because I certainly think that that kind of signal to the region would indicate 

we were serious about multilateral diplomacy, and diplomacy 

throughout the region has been lacking. In fact, I was involved 

when I was working in the Senate in creating a center as a component of a CINE PAC, which is known as the Asia-Pacific Center. 

And much to the dislike of the administration, I may say, who 

we had to force—as you may remember, we wrote that, legislation 

and then every year afterwards funded it through legislative initiative, the Clinton administration refusing all those years to even 

fund the center in Hawaii, which, of course, was intended to bring 

about military cooperation within the region. And I would also say 

that we recommended in our first report that the United States 

make a much greater effort to deal with the Chinese more successfully in building the creation of what are known as confidence 

building measures with the Chinese military. They’re almost totally lacking. And, in fact, what we discovered to our surprise was 

that Chinese have been very willing to build a rather detailed series of confidence-building measures with almost all the States on 

its periphery, including Russia, including India which it went to 

war with, including Southeast Asia, Laos and Viet Nam. And if 

they can build confidence-building measures with Laos and Viet 

Nam, it seems to me it would be useful to try and do that, which 

we did with great success with the Russians. And we’ve been very, 

very unsuccessful in doing that with the Chinese, which proved to 

be very dangerous. When we had the reconnaissance plane incident 

in Hainan, there was absolutely nothing in place to try and mitigate that crisis in the way of institutions and confidence-building 

measures. 

I have two questions. One is in terms of multilateralism, we 

looked into the question of Chinese energy development. And, of 

course, they’re going to become far more dependent on an accelerating basis on imported oil. And, of course, are in a frantic quest 

worldwide to build secure supplies of petroleum products. The 

question is, whether or not that’s going to be competitive with the 

west and the United States or whether it’s going to be cooperative. 

So the question is, what kind of effort do you think we ought to 

engage in to bring the Chinese into the IEA in terms of building 

more cooperative solutions to mitigating the problems that will 

arise as a result of, let’s say, an OPEC-created supply disruption 

or embargo in the future, or to try and build various kinds of cooperative arrangements in terms of the supply of oil to mitigate price 

gouging in the future? 

That’s the International Energy Agency I’m talking about here. 

Dr. SHIRK. I can’t answer that question because I’m not familiar 

enough with how the International Energy Agency operates and its 

practices and rules on managing oil markets. But let me address 

it from another angle. China’s dependence on imported oil, especially from the Middle East, is one of the reasons that it has beVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00199 Fmt 6633 Sfmt 6602 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
194 

come more concerned with preserving peace and stability in that 

region, as well as in other regions. 

Because, frankly, it went through the same evolution of its policy 

that we did. First trying to cultivate a special relationship with an 

oil supplier, like Iran or Iraq. And then later seeing that that’ that 

can be very dangerous because if that country is a spoiler, is a kind 

of troublemaker in the region, then everybody is going to pay more 

for oil. And you will not be protected from that. 

So now I think China has a fairly cooperative attitude with the 

United States in preserving a peaceful Persian Gulf region. 

But, also, I think there are real opportunities here in the AsiaPacific for cooperation based upon the common dependence of all 

the countries in that region on imported oil. And one of them is the 

protection of the sea-lanes of communication. That’s something that 

the United States has been doing alone, basically providing a collective good to the whole region at our expense. And, of course, it 

enhances our military influence in the region to do it that way. 

But I was just reading yesterday how China is actually considering building a canal through the Thai peninsula because the 

Strait of Malacca is such a perilous passage, especially in this age 

of terrorism. 

And they have, as many countries in that region do, some real 

anxieties about whether or not these tankers are adequately protected against a terrorist threat coming through the Strait of Malacca. 

During our Afghanistan and Iraq conflicts, the U.S. Navy, which 

had been stretched thin by having to engage in all these different 

theaters, actually delegated to the Indian Navy some of the job of 

patrolling the Strait of Malacca so that we could take our ships to 

do other things. Now, this is a potential confidence-building measures, I think there’s a potential for a more cooperative approach to 

patrolling the sea-lanes of communication in the region. 

Frankly, the U.S. Navy has never really been keen on that because they like their monopoly on that job. But it has a lot of potential for building a cooperative relationship and, by the way, 

helping the U.S. meet an important function in a more efficient 

way. 

Vice Chairman D’AMATO. Thank you very much. 

Dr. LAMPTON. I think that’s a very interesting question you’ve 

asked. 

And I agree with what Susan said. I would also say that yesterday’s testimony by Dr. May testimony is relevant to this question, 

and the power of markets to deal with this issue. 

But I think the way I would answer the question is to look at 

the ways in which China is trying to deal with this energy problem 

that it has. It certainly wants a stable Middle East and in that 

sense, strategically shares an interest with us, although China 

doesn’t always agree how you’re going to get that; but they want 

that result. 

The Chinese also are trying to build a strategic oil and petroleum 

reserve so that they can be insulated from the worst oscillations 

and not be forced into precipitous behavior. I think that’s probably 

in our interests. 

195 

They are also trying to diversify their sources away from a particularly volatile region working in Africa, Venezuela, Australia, Indonesia, and so forth. 

Also, they’re inviting in the foreign oil producers. Originally they 

started only having foreign energy firms offshore: now we’re getting 

more and more involved. I was just in a meeting with BP Amoco. 

They’re talking about building a natural gas line from Russia 

into Northeast China. So I think there are commercial opportunities for the U.S. Also, the PRC is trying to conserve energy and actually has a pretty impressive record on energy conservation. And 

that could help U.S. exporters of technology and so forth. 

So I think the Chinese are trying to deal with this energy problem in a responsible way. And, for the most part, I don’t see a big 

conflict of interest yet. 

Vice Chairman D’AMATO. Thank you very much. 

Chairman ROBINSON. I would like to turn to Ambassador Ellsworth next. Ambassador Ellsworth, as you know, is cochairman of 

this field investigation. 

And, again, this morning we want to reiterate a point made yesterday, which is we owe him a great debt of thanks for all he did 

to coordinate with the University of California at San Diego and 

many of the team in front of us today to make this highly valuable 

event transpire. And with that, I would like to turn to Cochairman 

Ellsworth. 

Co-Chair ELLSWORTH. Thank you, Mr. Chairman. 

Well, I have three or four specific questions, which I’ll get to 

quickly. But first I want to tell you how much I appreciate the panelists this morning, and hearing the way they think. They draw 

things together. They don’t just deal with this little problem and 

that little problem. But if they do, they bring it all together. Your 

comprehensive way of thinking and talking about China and its 

surroundings is very much appreciated. Following up on the energy 

discussion about China’s expansion and diversification of its energy 

sources. 

One of the most interesting to me of their efforts to diversify has 

been their interest in a huge gas deposit in Siberia called 

Kovyktinskoye Amphitheater. It’s the name of a big geological formation up by Lake Baikal. It’s a huge gas deposit. 

The Russians want to monetize it, that is, sell it for money. And 

the Chinese need it for their diversification of energy sources, and 

that’s going to happen. 

BP already owns 25 percent of that particular gas deposit. And 

they’re talking, in turn, to some American companies that they 

might draw in and help develop it. 

And it’s going to require a huge transmission line for the gas. It’s 

going to use all the steel capacity of everybody that produces steel 

in the world to build this pipeline within a reasonable amount of 

time. So it’s a big deal. And accordingly, it’s taking a long time to 

work it out between the Chinese and the Russians. 

And in that process—I’m sure, just as the same kind of an arrangement between the Russians and the Germans many years ago 

had a huge effect on geopolitics, was heavily responsible for 

Ostpolitik in those days. So now I want to come, to your remark, 

Dr. Shirk, about the Shanghai Cooperation Organization, the SCO. 

196 

Even before the development of the SCO, the Russian Prime 

Minister, Mr. Primakov, was talking about the development of an 

anti-hegemonial alliance between Russia and China. 

And ever since that has stimulated a lot of comment in the press 

and in academia and in the corridors of power about how that is 

an incipient possibility, an anti-American alliance between those 

two great powers. 

I wish you’d comment on that, including the geopolitical effect of 

this huge transfer of gas from Siberia to the east coast of China. 

Dr. SHIRK. Well, thank you very much for the question. I do believe that the China-Russia relationship is very important, and we 

need to pay close attention to it, especially when we’re talking 

about the regional context. 

Let me describe in very bald terms what I think the situation is 

in Sino-Russian relations. 

The Russians have tried at several points in time, including 

when Primakov was there, then later when Putin came in, right at 

the beginning of the Putin reign, to try to develop a common front 

with China against the United States. And from my knowledge, I 

believe that the Russians really took the initiative on this in trying 

to build common cause with China. And in some cases they even 

talked about maybe bringing India in as a coalition to block and 

restrain the United States. One focus of it was national missile defense. Before Putin agreed to strike a deal, before he turned and 

decided to cooperate with the United States in our leaving the 

ABM treaty and moving forward with national missile defense, he 

was trying to build a coalition against it. The Chinese have always 

been very cautious about this idea because, frankly, given the state 

that Russia is in these days, it really doesn’t look like a winning 

proposition for China to join with Russia against the United States. 

From China’s perspective, they’re much better off trying to cooperate with the United States. They’re better off economically. 

They’re better off politically. 

And so—although from time to time they’ll issue some pronouncement with the Russians just to keep us on our toes and to 

remind us that they always have the option of going in that direction, they don’t think it’s a winning proposition for them. 

Also, there’s a lot of remaining mutual suspicion between Russia 

and China. My perspective on this is that it’s a self-limiting relationship, that the United States doesn’t have to do anything to try 

to prevent Russia and China from getting closer because I don’t 

think they’ll ever be very close again. 

Co-Chair ELLSWORTH. Let me just follow up if I can, Mr. Chairman. 

Chairman ROBINSON. Please. 

Co-Chair ELLSWORTH. And I mentioned that already, back even 

in the depths of the Cold War, German Ostpolitik developed to 

some extent out of its dependence on energy supplies from Russia. 

Now then, you’ve implied, though you didn’t really say, that the 

Chinese have considered in recent years this Russian idea of an 

anti-hegemonial alliance, though they’ve rejected it for good and 

sufficient reasons. 

But now cast your mind five or ten years into the future. If they 

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197 

sia and if they continue to consider it, isn’t that something that we 

ought to be thinking about and noticing and tracking? 

Dr. SHIRK. Well, I think it suggests that we have an interest in 

China diversifying its energy suppliers, just as Mike Lampton said. 

And, therefore, instead of trying to discourage it, it suggests that 

it’s something we should encourage in order to reduce the dependence of China on Russian energy supplies. 

Co-Chair ELLSWORTH. Now, one more quickie, if I may. 

In speaking about China’s role in Asia and your brilliant comprehensive overall, you didn’t once mention the word ‘‘Taiwan’’— 

which is—if I can say so, at least consistent with the Chinese view. 

But Professor Krauss mentioned Taiwan very interestingly—in a 

way that I had never heard of before. And that was that Japan has 

implicitly included TaiwanDr. KRAUSS. Maybe. 

Co-Chair ELLSWORTH. —contingent on future developments in its 

sphere of security. Just give us a few words of your wisdom on the 

Taiwan situation. We’re in the middle of a kind of an uproar about 

Taiwan because of the presidential election. 

Dr. SHIRK. I didn’t talk about Taiwan because I was talking 

about multilateral diplomacy. 

Co-Chair ELLSWORTH. Right. 

Dr. SHIRK. And, of course, China would like to freeze Taiwan out 

of all those multilateral activities. 

Co-Chair ELLSWORTH. Right. 

Dr. SHIRK. APEC is the one that Taiwan is a member of. And 

I think that’s one reason that China is somewhat less enthusiastic 

about APEC than it is about some of the other multilateral organizations in the region. 

Taiwan is the one issue, I believe, in the Asia-Pacific region 

where the United States and China have somewhat different interests. China is determined to prevent Taiwan independence. 

And the United States, frankly, has a kind of ambivalent attitude about that. On the one hand, we don’t want to risk a military 

confrontation with China over Taiwan, and so we want to manage 

the situation to prevent that. On the other hand, we have a strong 

commitment to the people of Taiwan, which has grown stronger as 

Taiwan has democratized. And Taiwan has tremendous breadth of 

support within the United States from the public and especially 

from the Congress. So that’s the dilemma for the United States. 

Co-Chair ELLSWORTH. Thank you. 

I’d like to ask Mike Lampton—— 

Dr. KRAUSS. Can I just jump in here? 

Co-Chair ELLSWORTH. Excuse me. Yes. Go ahead. 

Dr. KRAUSS. Just on the Taiwan issue. I think I make it a little 

clearer in my report, but in some ways the Japanese elite is a little 

out ahead of public opinion on the Taiwan issue especially. 

I don’t think there’s any question in the world that in a conflict 

in the Korean peninsula, that Japan would be totally supportive 

and the public would. I personally have some doubts that in a potentially disastrous conflict with China over Taiwan that the Japanese public is going to be willing to risk war over that. I think 

Japan has a vested interest in making sure China and the United 

States do not come into conflict over Taiwan. 

198 

And I think they’re keeping this vagueness, in part, to help deter 

Taiwan from doing that, as well as to keep their options open. 

But it’s not clear to me that the Japanese public would support 

a war against China. It would very much depend on the circumstances, I think, of whether the confrontation with China over 

Taiwan seemed—China seemed to provoke that confrontation or 

not. 

Co-Chair ELLSWORTH. Mike. 

Dr. LAMPTON. Just on Taiwan, I wanted to react to one thing 

Susan said, and I agree with it, but I would put in a ‘‘but’’ when 

she talked about the great breadth of support for Taiwan. That’s 

true, and we all know the dimensions in which it’s true. 

I would add, though, that that support is very much contingent 

on Taiwan being, let us say, mindful of U.S. national interests. 

There’s a widespread perception that this administration started 

with a very positive orientation from Taiwan’s point of view. I’ve 

never, frankly, in the last 10 or 20 years, seen Washington-Taiwan 

relations more tense. Even more importantly—because somebody 

mentioned Congress—some people who have been, what we might 

say, very traditional and strong supporters of Taiwan wonder if the 

current government in Taiwan is being sufficiently mindful of the 

fact the United States is tied down in Iraq and Afghanistan and 

trying to find Osama bin Laden. 

There’s a further understanding that, yes, the people of Taiwan 

are entirely—have it within their decision-making purview—to vote 

on anything they want. But that doesn’t obviate the need for the 

U.S. Congress to, in fact, decide when the United States is going 

to get committed to war. We didn’t delegate that to the people of 

Taiwan. So I think, yes, there is this broad support for Taiwan, but 

I think there are limits. And I hope people in Taiwan understand 

them. 

Co-Chair ELLSWORTH. Thank you. Mr. Chairman, thank you very 

much for the time. And if there’s time later on this morning, I’ll 

come back with even more questions. 

Chairman ROBINSON. Excellent. 

Excellent. That was a very valuable exchange. I would like to 

turn over the proceedings to Commissioner Mulloy, followed by 

Commissioners Dreyer, Reinsch, Bartholomew and Becker. Commissioner Mulloy. 

Commissioner MULLOY. Thank you, Mr. Chairman. 

Let me thank each of the panelists. 

I’ve read your testimony with great interest, and you’re helping 

educate us, which is important. We’re not experts, and we’re—we 

value an opportunity to read testimony like you’ve given us. 

Dr. Shirk, you started out by saying that—yesterday we looked 

at the economic issues and now we’re looking at the political issues 

in the region. 

And you all make the point that China’s rising economic power 

gives it increased political and even military power so that the 

three are all interrelated. And that’s the theory upon which this 

Commission was created. We’re called the Economic and Security 

Review Commission because Congress, when setting us up, accepted that premise entirely. 

199 

In fact, we think of going back to the old Golden Rule. And you 

know what the Golden Rule is. He who has the gold, makes the 

rules. And we’re sending the gold to Asia at a pretty quick pace. 

The United States is running a current account deficit of $500 billion this year. We’re the largest debtor nation in the world. 

And 60 percent of our trade deficit is with Asia. Okay. Now take 

those premises. 

Now, Dr. Lampton tells us that one way we help finance our own 

budget is that the Chinese, through the dollars they accumulate 

through the $125 billion trade surplus that they run with us, they 

buy U.S. treasuries, which then helps us finance our spending, 

which we’re not taxing ourselves, so it helps keep our interest rates 

down. 

Then the further question that comes up—Dr. Lampton says that 

this idea that China might be manipulating its currency, I don’t 

think you were too enthusiastic about that issue being raised. 

This Commission in September held a hearing on China and 

other Asian countries manipulating their exchange rates to gain 

trade advantage. And what does that mean? 

That means they intervene in their currency markets to keep 

your currency under value. What does that do for you? 

It makes it easier for those countries to export to the United 

States. It makes it more difficult for the United States to export 

to Asia, which then increases our trade deficit with these countries. 

There’s a massive transfer of wealth. Now, the United States in our 

hearing—we did a hearing in September, and we found out China 

was manipulating its currency. The dollar has fallen 30 percent 

against the Euro in the last year and a half. It has not moved at 

all against the Chinese currency and other Asians who tie their 

currency to the Chinese. 

So the question I have is, Dr. Lampton, you say, it’s kind of unseemly to raise that kind of issue. This is what I get from your testimony. For example, you say, quote, ‘‘when in late 2003 many in 

Washington called for Beijing to revalue or float its currency, few 

in Asia supported the U.S. position.’’ 

Well, why would they? They’re all benefiting from this manipulation. 

You say, as ‘‘Taiwan’s China Post’’ put it, ‘‘the notion of getting 

Beijing to relax its currency controls is an American economic priority and it is an American economic priority in both parties and 

in the administration is hardly a top goal in this part of the planet.’’ 

And you seem to imply both in your testimony and what you said 

here this morning that that’s kind of unseemly to raise issues like 

that. And let me just—because my view is, is kind of like the Godfather. This isn’t an unfriendly act. This isn’t personal. This is 

business. 

And we ought to take it up in a very serious manner. And I just 

would like to get the panel’s views on that because you’re political 

experts, but I think that the two are interrelated. 

Dr. LAMPTON. Seeing how, Commissioner, you mention my testimony, let me make it clear, which I think it is in here, the context 

in which I was meaning that. 

200 

I was saying as more and more countries become suppliers of 

China, they are going to share the economic policy priorities of 

China. I’m not saying that’s a good thing. And in many respects it’s 

probably not in our interest. So I want to make that clear. 

But when you have Taiwan—at least a Taiwan newspaper sharing the economic priority of China, there’s something going on 

there. And I’m just saying that as China’s economic power grows, 

don’t expect everybody in Asia to go lockstep with us in our demands against China. I’m not advocating that. I’m just describing 

that. So I want to be clear about that. Also, just with respect to 

the currency issue. In 1997 and 1998, there was the Asian financial 

crisis, and everybody wanted China to manipulate its currency— 

that is, not devalue—and by government fiat keep it stable so there 

wouldn’t be a downward spiral. 

So all I would say is when China—China has kept this peg for 

a number of years. There have been times when we were, in fact, 

enthusiastically endorsing it, and now we’re—let’s put it this 

way, we’re opposed to it. So all I would say is you take a longer 

historic period, and I don’t mean decades, I mean just the last five 

years. There have been periods when we have been urging China 

to do it, and now there’s a period where we wish they weren’t doing 

it. 

What I can tell you is I’ve had some conversations with Chinese 

economists, and there’s interesting things coming out in the Chinese press. I think the Chinese are coming to the conclusion that 

a limited upward valuation of their currency might be good for 

them. And I think just as we make our economic policy based on 

what’s good for us, the Chinese do. I don’t expect to see it in the 

next three weeks, but the fact of the matter is I think the Chinese 

are concluding that their present peg level is contributing to inflationary pressures in China. 

So, I think they’re thinking about a basket of currencies and so 

on. But China has an enormous stake in just keeping predictions 

stable for foreign investors and so on. 

So I think we have to be a little patient. But the Chinese aren’t 

totally unresponsive. They make policy based on their interests. 

And—but my larger point wasn’t whether it’s good or bad, reasonable or not; it’s that as people have more economic stakes with 

China, they’re going to more frequently take China’s side. 

Dr. KRAUSS. Along with putting it into a broader historical perspective here, the Japanese did the same thing for the last 30 

years, keeping their currency above a certain level to some extent, 

to the extent that they could, below a certain level in order to aid 

their trade. And in even broader context, all countries do this to 

some extent. Lest we cast too many stones, I would like to remind 

people that Nixon let the dollar float when the U.S. was in economic trouble, Reagan kept the dollar high for political reasons, 

and we negotiated the Plaza Accord when we felt that the yen was 

overvalued. So, all countries at a certain point do try to advance 

their own economic interests when they feel that the currency exchange rates are out of line with those interests too far. 

Dr. SHIRK. Very briefly, I think in making this a major focus of 

U.S. policy attention, we should do a cost benefit analysis from the 

standpoint of U.S. interests. 

201 

And on the one hand, the potential benefit would be to narrow 

the trade gap with China by a small amount. Obviously not by a 

very large amount because that trade gap is based on a lot of other 

things, especially labor costs that go beyond the pegged currency. 

But then on the negative side, think about some of the issues that 

Mike Lampton has raised about the impact on other countries in 

the region. And also, think about what we’re signaling to the AsiaPacific in a larger political sense. 

After the Asian financial crisis, the Asian countries felt that the 

U.S. really didn’t have their interests at heart, that we didn’t have 

the right approach, and that was the impetus for them to develop 

the ASEAN Plus Three approach, which leaves out the United 

States. 

If we focus so much and really hammer away hard and apply a 

lot of gaiatsu on this issue, we run the risk of the same kind of 

backlash in the region. 

Commissioner MULLOY. Thank you. 

I hope we can come back to this issue later, Mr. Chairman. 

Chairman ROBINSON. I suspect we will. Commissioner Dreyer. 

Commissioner DREYER. Yes. I have a couple of quick questions 

for actually each one of you. And to start with, Dr. Shirk, I was 

interested in what you said about more multilateralism. And I am 

wondering if you think it’s really going to do any good, because, you 

see it from a different perspective, obviously, than I do. 

And it seems to me I am always seeing Armitage jetting around 

the world into Asia saying something, or one leader or another. 

And it does seem to me that we really look as if we’re out there 

a fair amount of the time trying to convince people, but we don’t 

seem to be able to convince them. 

And the problem with more multilateralism may be that we try 

harder, but still don’t manage to convince people because, in fact, 

they don’t agree with us. 

And, also, to consider the—which they sure don’t about Iraq, 

right? 

And the other question is, I suppose, to consider the trade-offs 

between putting somebody in Honolulu and the problems that 

causes with the home office in Washington. 

And the example, I guess, that comes to mind is the APCSS, 

which was put in Honolulu to encourage military cooperation, and 

the head of it developed his own policy, which was different from 

that of the Defense Department. 

Dr. SHIRK. Would you like me to respond? 

Commissioner DREYER. No. 

Dr. SHIRK. Okay. 

Commissioner DREYER. And things like this happen just because 

bureaucracies tend to behave that way. 

For Dr. Krauss, I have been watching Sino-Japanese relations for 

some years, as you know. And recently Chinese have been saying 

to me, I think you and I both notice there’s just kind of a schizophrenia involved in China’s view of Japan. 

On the one hand, it’s this dinosaur-egg-about-to-hatch militarism. And the other half—the other side of the schizophrenia, 

people have been saying to me recently, Chinese people, well, you 

know, Japan is really a declining power. And they can’t seem to 

202 

solve their economic structural difficulties. And they’ve got this declining population that’s getting older. And, of course, this, what do 

you say, ignores the fact that China can’t really seem to solve its 

economic structural problems, as well. And more than 10 percent 

of the Chinese population is also aging, and it’s becoming more serious with time. 

But I wonder—I know you read Japanese newspapers every 

day—any resonance in Japan from that? Are there Japanese who 

would agree with that, and do you see any implications for the future on that one? And, Dr. Lampton—and, again, maybe this is because I misunderstood. But I thought I heard you say that it is 

China’s developmental model that was attracting students from 

Asia and particularly Korea to China and—to study. And again, my 

impression—and maybe I’m not right on this—is that it isn’t China’s developmental model that’s attracting these people; it’s the 

hopes of making money from China. And I have yet to hear any 

student—and, again, I don’t talk to the same people you do, but 

any student saying—from Burma or Thailand or—say, oh, boy, let’s 

adopt the Chinese developmental model. 

And, also, a question on, when you say a strong China will be 

helpful to us in solving security problems. I am a little bit skeptical 

of that one because it seems to me that China will help us solve 

security problems when China sees the security problem the same 

way we do. But the problem just thus far is we—we and the Chinese don’t seem to see the security problems from the same point 

of view. 

That’s it. 

Dr. SHIRK. Just very briefly. I’m not surprised that folks in Asia 

don’t agree with the United States on Iraq. And I don’t think that 

regional multilateral involvements are going to solve that problem. 

I think it does, however, give us another platform and a way to 

explain why we’re doing what we’re doing, and also, to hear. 

Very often the United States—when we send a senior official out 

to the region, which happens, in my view, all too infrequently, we 

have a lot to tell them, and we don’t listen very much. 

So I think the good thing about doing this multilaterally is that 

you get to explain why you’re doing what you’re doing. But you also 

have to listen. You have to sit there, glued to your chair, and listen 

to what other folks have to say. 

Commissioner DREYER. So the problem is really that we go, although maybe not as often as we should, but we’re not listening 

when we’re there. 

Dr. SHIRK. Well, I think that’s part of the problem. I think even 

in our bilateral alliances there’s less give-and-take than I would 

like to see in our practice of bilateral diplomacy, as well. 

And then as to the problems of designing a structure, which 

would give us a more continuous presence in the region, that is a 

very tough problem. 

I think, however, that we might look at the private sector. We 

have lots of examples of worldwide organizations that have figured 

out a way to do this and integrate operations with centers in different parts of the world. 

Now, of course, the American Foreign Service and the Diplomatic 

Corps is that kind of system; for example, the Europe bureau of the 

203 

State Department does have more attention paid to regional affairs 

than the East Asia bureau does. And it’s done at a higher level. 

And I think that that’s the sort of thing that I would like to at 

least explore, perhaps looking at private corporate models for how 

to do that best. 

Commissioner DREYER. Worth a try. Yeah. Dr. Krauss. 

Dr. KRAUSS. Yes. I’m going to respond to your question, but just 

let me say something about multilateralism. I’ve studied the U.S. 

and Japanese roles in APEC particularly. And I have to say it’s one 

thing to send people; it’s quite something else for other countries 

to get the impression you’re quite serious about multilateralism, 

that it’s not just something you’re doing or the Japanese say, 

‘‘tatemae’’ as you know. 

It’s not just something you’re doing because you have to, but 

you’re not really committed to it. You really do like bilateral relations better because they advance our interests in one way. 

Who pays for most of the multilateral organizations in Asia? 

Somebody once told me the State Department budget for APEC 

was $40,000. 

Commissioner DREYER. Really. 

Dr. KRAUSS. Yes. Whereas, the Japanese pay for most of the multilateral activities that go on in these economic organizations. And 

that’s a better sign to countries, I think, that Japan is quite serious 

and has a much higher priority on multilateral organizations in its 

foreign policy than we do. And I think that helps Japan, frankly, 

to a large extent. 

Let me just answer your question a little bit. Yes. I might say 

that China—Chinese people are not the only people who seem to 

count Japan out. I believe that’s a fairly common view within the 

beltway in the last ten years, the impression I get when I go to 

Washington. It’s called Japan passing now. It’s not Japan bashing 

anymore. The common wisdom in the beltway for ten years at least 

has been Japan passing. 

We can’t do anything with them. They’re a declining power anyway. They’re over the hill. Let’s concentrate on Southeast Asia and 

China. That’s really the impression I get of Washington’s view, as 

well, for the last several years. 

Commissioner DREYER. Well, can Japan come back? 

Dr. KRAUSS. Well, there is something to what you’re saying. I 

think there is definitely a decline of Japanese confidence in themselves as a result of 13 or 14 years of recession that seemingly 

never ends. 

This is a country—if you have been in Japan recently, you know 

some of the bullet trains have painted on the side ‘‘ambitious 

Japan’’ and advertisements for young people to become more competitive and ambitious. 

Just the fact that the Japanese, of all people, have to advertise 

to their young people to be ambitious tells you something. 

And that’s certainly not the Japan that I knew back in the ’70s 

and ’80s. But at the same time I think it’s very easy to exaggerate 

this both by the Japanese themselves and in Washington and 

China. 

Japan may be recovering right now. It’s always going to be 

strong in some manufacturing sectors, particularly—they’re far 

204 

ahead of us in telecommunication—I shouldn’t say this in an area 

of QUALCOMM, but they’re far ahead of us in telecommunications, 

cell phone technology, for example. 

And they, I believe, will continue to be a major player in Asia, 

but the Japanese are quite aware that they may have to share that 

role. And there is going to be some competitiveness with China in 

the interim period. 

Dr. LAMPTON. Commissioner Dreyer, on the attractiveness of the 

Chinese model, your question leads me in the direction of trying to 

refine my remark in two directions because I think it is subject to 

the understanding you had. 

One is that people throughout Asia are attracted to the success 

of China. 

Commissioner DREYER. Yeah. 

Dr. LAMPTON. And that’s what I meant by the magnetism of economic power. 

Moreover, there’s a subset of people that actually finds the model 

attractive. I was at a group meeting with some Russians the other 

day. It came up that the Russians found certain parts of the Chinese model attractive because they had had the same economic system as Chinese had and they’re trying to get out of it still in some 

measures. 

And also Vietnam and North Korea in a more distant future find 

elements of the Chinese model attractive. 

So I think there is certainly a subset that actually finds the 

model attractive. Certainly the success is attractive. 

Commissioner DREYER. Any particular features of the model that 

they mentioned? Anything specifically? 

Dr. LAMPTON. Well, first of all, the rapidity with which the Chinese let the small and medium enterprises go, the degree to which 

they brought in markets, commodity markets, stock markets and so 

forth, the rapid introduction of labor markets. We have to distinguish between Russia and North Korea and Vietnam and so forth. 

But the gradualism and pragmatism where the Chinese let something happen regionally, saw what was working, and then promoted that model if it seemed to be working is attractive. 

So maybe it is as much about Chinese character and pragmatism 

as it is anything else. You said you were skeptical, I believe was 

the word, about the security cooperation aspect of what I had to 

say. And I think at the end you said, if I understood correctly, that, 

well, they will cooperate in a parallel way if they see the problem 

the same way that we do. 

Commissioner DREYER. Yeah. And we often don’t. 

Dr. LAMPTON. Of course. Well, that’s 

true—that’s true among big powers per se, whether it’s China or 

anybody else. 

I would say that I think that the very thrust of Chinese development is leading them to have an array of interests that more and 

more frequently has them seeing the problem, if not identical to us, 

at least in parallel ways. That leads them for their own interests 

to behave in ways that are more compatible with our interests. So 

I don’t dispute what you were saying; I just think we’re in a 

happier stage where they are getting more interdependent in the 

205 

world. They have an interest in a broader and broader set of stable 

relationships that increasingly parallel our own interests. 

Commissioner DREYER. Thank you. 

Co-Chair ELLSWORTH. May I intervene on that point? 

Commissioner DREYER. I’m done. 

Co-Chair ELLSWORTH. I have been sitting here thinking ever 

since you asked about that. 

Well, haven’t they cooperated with us on the North Korea security problem? Haven’t they cooperated with us on terrorism? 

Haven’t they cooperated with us on helping resolve the India-Pakistan frictions to some extent? I’m not an expert. 

Commissioner DREYER. This is for a very lengthy other conversation, not for now. 

Chairman ROBINSON. Commissioner Reinsch followed by Commissioner Bartholomew. 

Commissioner REINSCH. Thank you. 

Thank you, all three of you, for your very sensible testimony. I 

hope we remember it when it comes time for us to write our report. 

For those of us whose minds are going, like mine, it’s always a 

question. But since it’s in writing, I’m confident we’ll be able to remember it. Dr. Lampton, I thought one of the wisest things you 

said—well, you didn’t say it. It’s in your written testimony. And I 

would like to have you elaborate on it a little bit orally, and that’s 

something you said at the end of your testimony in which you 

talked about the U.S. placing greater emphasis on economic, social 

and political development through institution building, talking 

more about development as a process, rather than simply as an end 

state in which there is democracy rule of law and human rights. 

Could you briefly elaborate on that. 

Dr. LAMPTON. Yes. I think you’re always more effective when the 

departure point of what you’re advocating for others recognizes the 

process through which you, yourself, have gone. 

Any fair reading of American political, economic and social development would say that the last 200 years of our history has been 

a constant enlargement of the franchise, participation, equality and 

so on. 

And it’s also been an increasing struggle to find that balance between government intervention and innovation and individual initiative. 

I don’t see why the United States can’t understand that when 

you are responsible for 22 percent of the world’s population and 

moving part of it from literally feudal circumstances 30 years ago 

to something much more integrated into the world, that you’re 

going to face problems, this is going to take time, and above all, 

you need institutions and rules. 

Achieving this takes a lot of time because it’s not just training 

the personnel. It’s not just building a body of laws and rules. But 

it’s actually embedding these patterns of behavior in the hearts of 

22 percent of the world’s people so they spontaneously behave in 

accordance with those rules. That’s going to take time. And I don’t 

see why we have so much difficulty incorporating that into our policy. 

So all I was saying is, yes, we have these objectives. Yes, what 

we advocate ought to push in those directions. But, with no disVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00211 Fmt 6633 Sfmt 6602 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
206 

respect intended, we often feel much more comfortable about talking about the end state because, in fact, we don’t have to put any 

resource into the end state. 

If we start talking about building institutions and helping in 

that, that’s going to be an expensive process. That’s what we did 

in the Marshall Plan. We didn’t just talk about the Europe we 

wanted; we contributed to it in a very tangible way. 

So all I’m saying is, really, we need to recognize it’s a long process. Rather than focusing so much on the deficiencies, let’s focus on 

the infrastructure that makes it possible to have the world we 

want. 

Commissioner REINSCH. Thank you for that. I think that’s very 

helpful. Dr. Shirk, and the other two of you, feel free to comment 

as well, but I want to start with Susan. 

Leaving Taiwan aside for the moment and looking at the region, 

do you think that the United States and China have fundamentally 

incompatible regional visions? 

Dr. SHIRK. No, I don’t think they’re fundamentally incompatible. 

I don’t think there are any other specific conflicts of interest, other 

than possibly Taiwan. The big question is what is the role of the 

U.S. in the region and what is the role of China in the region? 

And at present, U.S. explicit policy is to prevent the rise of a 

peer competitor in the region. In other words, we view ourselves as 

the regional hegemon and that we want to remain the regional 

hegemon. 

I think there’s a very real question about whether or not that’s 

a realistic objective, given everything else that’s happened in the 

Asia-Pacific in the last couple of decades and is likely to happen 

in the future. 

China, after flirting with the idea of trying to bring the U.S. 

down and push the U.S. out of the region militarily, which is something that they actually said, at least the academics did in the 

early ’90s, they’ve completely backed away from that now. 

And, in fact, one of the reasons they want to have these confidence-building measures, military ones, multilateral, as well as 

with the United States, is to signal to us that they no longer want 

to push us out of the region militarily, that they can live with the 

continued military presence of the United States and they’re willing to work with that, to cooperate with that. Mike Lampton talked 

about the kind of adjustments that are really required by the rise 

of China and by the other changes in the region. And I think one 

of those is to recognize that in the future, the way for us to maintain our leadership in the region is by sharing the responsibility for 

the management of the region with other powers, meaning China, 

meaning Japan, meaning Russia, meaning ASEAN. So it’s not 

something that we can do alone anymore. 

Commissioner REINSCH. Do either of the other two of you want 

to comment on that? 

Dr. KRAUSS. Just to point out a long-term historical perspective. 

I’m always struck by the fact that if you look at U.S.-East Asian 

history, there are very few—very short periods and very few of 

them where the United States did not somehow feel the necessity 

to have one friend and one enemy between Japan and China. 

They’ve always reversed roles somehow over different time periods. 

207 

And I think that’s a very—I mean, if we do that again—I just 

want to warn against doing that again. Obviously, clearly, Japan 

is our friend, at least on security matters. It’s our rival in many 

ways, as well as our partner on economic matters. I think we have 

to be very careful of the danger, that we don’t demonize China, 

once again, to make sure that we have one friend and one enemy 

or rival in China. 

I think the challenge for American diplomacy in East Asia in the 

future is going to be balancing these two people who or can be potentially our friends and certainly they are our economic partners 

even while they’re rivals in other ways. 

Dr. LAMPTON. I thought that was a really terrific question. I 

think it frames the anxieties. 

What is China’s ultimate goal? To get us out of Asia is one formulation. 

I would say no, it isn’t. I agree with everything Susan said. I 

would just make two points. 

One is, China doesn’t want to be left alone in Asia with Japan 

any more than Japan wants to be left alone in Asia with China. 

So that’s the first point. Secondly, the Chinese learned a central 

lesson from the collapse of the Soviet Union, and that is, the 

basis of comprehensive national power is a vibrant domestic economy, not a defense structure into which you are pouring endless 

amounts of money at the cost of your domestic human and technological resources. 

And so the last thing they want to do is to pay all the freight 

protecting oil shipments to China through the Straits of Malacca 

or anywhere else. 

I think they’re rapidly coming to the conclusion that a shared security burden is the course most compatible with their continued 

economic growth. 

What they don’t want however is a U.S. that’s trying to, as they 

would put it, separate Taiwan or contain China. And as long as 

they conclude that’s not our principal purpose, I think they want 

us there. 

Commissioner REINSCH. Thank you. 

Chairman ROBINSON. Commissioner Bartholomew followed by 

Commissioner Becker. 

Commissioner BARTHOLOMEW. Thanks very much. And thanks, 

again, to all of our witnesses and everyone who hosted us here. It’s 

been really wonderful. 

I’ll start just with a brief comment since Commissioner Reinsch 

raised the issue, which I think is important to remember that U.S. 

support for human rights and democratic reform in China is the 

U.S. supporting the hopes and aspirations of the Chinese people 

whose own government is responsible for denying them basic freedoms—freedoms that are enshrined in the Chinese constitution and 

international obligation. To me, that’s a very important part of the 

framework. 

I have a rhetorical question more than anything else, and then 

a couple of specific questions. My rhetorical question relates to the 

Chinese currency revaluation issue. I guess I would just say is it 

not possible, perhaps even likely, that the Chinese could time their 

revaluation to have an impact on the U.S. presidential election? 

208 

I’m not sure anybody really wants to take that on, but if you 

have thoughts about that, it would be interesting. 

Dr. Lampton, I was interested in your remark on sanctions about 

the 85 cents cost out of a dollar. My comment there would only be 

that that presupposes that there isn’t somewhere else that the production could be done. 

And it’s my understanding that during SARS last year, in fact, 

a number of textile manufacturers were looking at the possibility 

of having to transfer production to Vietnam or to some other 

places. It’s not without cost, but it is indeed possible. I just wanted 

to put that out. But my question specifically, Dr. Lampton, is actually about your comments on the war against terrorism. I was really struck by what Dr. Shirk said about that—that in the Chinese 

mind, terrorists, separatists and extremists are all the same, which 

is, of course, a code word for the Uighurs, the Tibetans, and the 

Taiwanese. And we hear a lot about how the Chinese are cooperating on the war on terrorism. I wonder if you could give us some 

specifics about something other than them using the war against 

terrorism as an excuse to crack down on the Uighurs. 

Dr. LAMPTON. You mean give other—— 

Commissioner BARTHOLOMEW. Yes. Well, what are some examples of how specifically they’re cooperating with the U.S. in the war 

against terrorism? 

Dr. LAMPTON. I will do so. I would also invite you at some point 

to have people from the National Security Council and so forth testify to this. They’re privy to more information, and they, I think, 

in general, would be more useful to you in answering the question 

than I. 

But several things come to mind. One is the Container Security 

Initiative at the Commerce Department, and I just spoke with Secretary Evans not very long ago. As I would understand it, there are 

20 ports around the world that have the biggest volumes of containers coming to the United States. 

The United States has asked China to station in these ports U.S. 

personnel to pre-inspect those containers and assure they don’t 

have weapons of mass destruction. 

Many of us that have studied Chinese history thought, when we 

first heard the idea of putting U.S. FBI or Customs deputies in 

Chinese ports—that, the Chinese would filter this through the treaty port mentality and reject it out of hand. 

In fact, they have not. They have been cooperative. The ports involved are Hong Kong, Shenzhen, and also Shanghai. And so the 

Chinese have been remarkably cooperative on that given what we 

might have expected given their framework. Commissioner Ellsworth pointed to several very important things in his dialogue with 

Commissioner Dreyer. And that is that India and Pakistan; you 

may remember in the summer of 2002 we were afraid they might 

end up in a nuclear imbroglio. 

The Chinese on several occasions were publicly praised by the 

United States for tamping that down, particularly given their influence with the Pakistanis. 

Also, right at the very beginning of our intervention in Afghanistan, remember we were concerned about whether or not Pakistan 

209 

would cooperate with us. Musharraf spoke with the Chinese leadership personally on two occasions. 

And I have been told by the U.S. Government that, in fact, the 

Chinese encouraged their long-time ally to cooperate with the 

United States. So I think that’s an area. 

Certainly on the war on terror, if you look at the UN issue with 

respect to intervention in Iraq and so forth, although the Chinese 

were not enthusiastic, they found a way to avoid taking a public 

position such as the Russians and the French and the Germans 

took against us. Nothing in this testimony nor nothing that I believe would suggest that they’re central to the war on terror, but 

I think everyone would agree we’re better off with them in the tent 

than outside the tent. 

Commissioner BARTHOLOMEW. Okay. Anyone else on that one? 

No. 

Dr. Shirk, I know you focused on regional multilateral. But if we 

look more globally in terms of China’s participation in multilateral 

organizations, I wondered what your thoughts are as to how their 

participation might be changing the nature of the multilateral organizations. 

Two issues come to mind. Of course, one is there had been concern with China’s succession to the WTO and its lack of willingness 

prior to that to play by global rules. What impact it was going to 

have on the WTO. And the other one, which always comes to mind 

for me, is the UN Human Rights Commission where they influence 

by, I think, is what I would call, which is change the ability of that 

organization to function. Just any thoughts you have on that? 

Dr. SHIRK. On the Human Rights Commission, I—I believe that 

the U.S. is getting less and less traction on the Human Rights 

Commission for its positions, but I don’t really know enough to say 

whether or not that’s because of major mobilizational efforts that 

the Chinese have undertaken. 

Commissioner BARTHOLOMEW. They generally start the day after 

Geneva. 

Dr. SHIRK. Yeah, I know. Clearly, they have resented our resolutions against them. And they seem to care a lot about the normative opprobrium of the Commission, and they work hard to defeat it. But it’s not clear to me. If China were not doing that, would 

we, other than the China resolution, be getting more support on 

the Human Rights Commission? So I don’t know whether or not 

that’s actually changed the functioning of that Commission. 

On the WTO I think what’s very interesting is how the Chinese 

have committed themselves to working in the WTO organization 

and seem to be largely supportive of the initiatives of the United 

States and the West in carrying forward and having a second 

round that really goes somewhere. 

They have mixed incentives because they are both an agricultural exporter, as well as an importer, and their agricultural sector 

is under a lot of pressure because of opening up the market for agricultural products. 

So I think they kind of straddle the views of the countries like 

the United States and Australia and Canada that are major agricultural exporters and the ones who have very protected agricultural sectors. So, you know, China does try to speak for the develVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00215 Fmt 6633 Sfmt 6602 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
210 

oping world, but it does it in a much less idealogical way than it 

used to. And it is more willing to cooperate with the United States 

and other trading powers in the WTO than a country like India, 

say. 

I think that it’s a little early to say how it’s going to go yet. But 

so far China appears to be a constructive player and not a spoiler 

within the WTO. 

Dr. KRAUSS. Let me just add to that the history of Japan in multilateral organizations like GATT and the WTO is very instructive. 

Japan distrusted the WTO as nothing more than a front for American pressure essentially until it won a few cases, whereupon it has 

become extremely aggressive against all of its trade partners, 

against its trade partners in using WTO, including, as we were 

talking about that before, privately, challenging the 1916 steel law 

in the United States and winning and winning several cases. Now, 

that’s a double-edged sword because it means you could use it 

against your trading partners when it suits your interests, but it 

also means you have to abide by the rules when you lose. And, I 

wouldn’t be surprised if we see a similar trajectory with China. 

Dr. SHIRK. I agree—if I just may interject, one point is that there 

are all these antidumping cases all over the world, national ones 

against China. 

And I think that China is likely to use the WTO in the future 

to try to counteract that kind of reaction from particular nations. 

Chairman ROBINSON. Thank you. 

Commissioner Becker followed by some concluding remarks by 

Commissioner Ellsworth. 

Commissioner BECKER. Thank you very much, Mr. Chairman. 

I want to compliment the committee on the testimony that presented. I’m somewhat taken by the fact that there’s a high degree 

of similarity between each one of you on both your analysis of the 

problem and the suggestions and solutions. 

My colleagues have covered everything that I could think of except one thing. It’s the old story, everybody said everything that 

there is to say, but not everybody said it yet. 

This is a question I’ve carried around for a long time, waiting for 

the right committee or the right panelist to ask. It’s a little bit out 

of line of what we’ve discussed here. Dr. Shirk, when you said 

China has backed away from trying to oust the United States, at 

least in an influential position and probably a military position 

from Asia, I would suggest that they may have backed away, but 

not necessarily forgotten it. I think that’s just a subtle difference 

in the perspective. 

And a comment to Dr. Lampton. I’ve really enjoyed your discussion on the different types of power—diplomatic and economic and 

military power. We had a saying in the labor movement for a long 

time that there’s no sense in having power if you don’t use it. And 

I think that’s a doctrine that a lot of countries adopt too. 

When you don’t have the power, you use diplomatic arguments 

and maybe even economic, but when you have the power, the playing field changes a lot as the direction is going. 

I want to draw two points. When I said that’s similar in your testimony, it really is. 

211 

Dr. Shirk says on the first page about the Chinese, it’s a credible 

signal of China’s peaceful intentions or a Bismarckian strategy to 

grow stronger without provoking others to combine against it. And 

this goes back to the sense of power and the possibility of using it. 

But you don’t dismiss the possibility of them using the power, not 

at all. 

And Dr. Krauss talks about preventing a China-Japan arms race 

and conflict that would destabilize the entire region. 

So you, too, don’t dismiss the possibility of a conflict in that region. 

And you’ve alluded to it, Dr. Lampton, in several different ways. 

I don’t want to dwell on that, but I want to raise this question. 

United States business and other countries have invested billions 

of dollars into China. Some companies have transferred their whole 

business operation to China. 

I often wonder in my mind at what point in time an American 

company becomes a Chinese company. But their whole operation is 

gone from the United States, and they’re wholly invested in China. 

Others are partial. Some are in transition, like Motorola, which is 

the strongest, biggest investor in China, but more and more—literally billions of dollars of investment from Motorola, and they’re 

in a constant stage of shutting down plants in the United States 

and moving over there. I guess my question is, China is a communist nation. At times their behavior has been erratic and heavily 

authoritarian. And I’m not talking about historic memories. I’m 

talking about recent years. I point to Tibet. I point to Tiananmen 

Square. I talk to the EP 3 incident and certainly Taiwan. And the 

provocative position that they’ve taken often, including the firing of 

missiles close to the island in a very provocative way. building additional missiles and lining the coast with them in what can only 

be interpreted by the Taiwanese and the United States as their 

ally in a provocative way. We have other allies in the east that 

we’re closely aligned obviously to South Korea and Japan. So we 

have a vested interest in this whole thing. 

But for these American industries that have invested in China 

so heavily in varying degrees, do you perceive any kind of threat 

to these industries that have taken this bold step and put all their 

eggs in one basket in China? 

How would you assess that yourselves? 

Dr. SHIRK. I think there’s a lot of risk to investing in China. Not 

necessarily the risk of expropriation—expropriation that you might 

have to worry about in all developing countries, but the risk of a 

political internal conflict in China. 

I think the challenge of taking China from communist authoritarian country to a democracy peacefully is just a daunting challenge and that it’s most likely to be peaceful if that transition is 

led from above by a reformist communist leadership. And I’m actually quite discouraged that the pace of political reform has not kept 

up with the pace of economic reform, and that we’ve all had quite 

high expectations of this younger leadership team, Hu Jintao and 

Wen Jiabao. My friends in China are also concerned that this 

seems to be moving so slowly. 

So I think there’s a serious risk of domestic political conflict in 

China that is a major security risk to the United States and cerVerDate dec 18 2003 08:55 Apr 09, 2004 Jkt 201128 PO 00000 Frm 00217 Fmt 6633 Sfmt 6602 D:\CHINA\201128\201128.XXX APPS10 PsN: 201128
212 

tainly a risk for all the companies that are doing business in 

China. 

Commissioner BECKER. Thank you. Dr. Krauss. 

Dr. KRAUSS. Let me just assure George that any similarities in 

our testimony or reports are purely coincidental. I never met Mike 

before. And Susan and I are so busy, I don’t think we’ve ever 

talked about this previously. So— 

Vice Chairman D’AMATO. It’s the great minds thing. 

Dr. KRAUSS. Thank you. I’m glad you said it. 

Commissioner BECKER. I don’t believe in coincidence. 

Dr. KRAUSS. In fact, I was shocked to learn that there was a 

‘‘San Diego line’’. I had no idea. In any event, on the China-Japan 

rivalry, I think a lot depends on keeping the U.S.-Japan relationship strong as to whether or not that rivalry gets out of control. 

The worst thing in the world that could happen to the United 

States and Asia is for Japan to lose faith in the United States, develop its own independent military power and an arms race to 

ensue in Asia between China and Japan. 

I think it’s very important to keep the U.S.-Japan relationship 

strong. The dilemma for the United States will be doing that while 

not provoking China and convincing it that it’s all aimed at China 

because, then, this is the line we are going to have to straddle in 

the future. 

That’s, I think, very important. So a lot of us—a lot depends on 

us, frankly; it’s not just China and Japan. 

The other thing is about the threat in China. Japanese business 

has a little different attitude than American business. And that is, 

despite all the investment in FDI and Japanese government, they 

believe that the way to compete with China is to keep yourself competitive and go higher and higher quicker and quicker in terms of 

going up the value-added chain and stay one step ahead of the Chinese. 

And they’ve been very careful not to—in their investments in 

China not to transfer technology—advanced technology. Whereas, 

back in the ’70s and ’80s American businesses sold the store to 

Japanese companies in terms of technology transfer. And we 

learned too late that that was not a good idea. 

So I think a lot of the responsibility, again, is on American businesses to invest in China, carefully calculate the risks, and that includes the risks of giving too much away in those investments even 

while we make sure they’re productive. And, again, I don’t think 

any of us here disagree that human rights in China and the opening up of China democratically is a crucial issue for the future and 

very—a lot depends on that. 

I just think that we have different views. The Japanese don’t believe in pressure, and they don’t believe in the, as I said, military 

deterrence particularly yet. 

They do believe that if China develops economically long term, 

it will inevitably become more liberal and more democratic. 

I’m always—I find that ironic because there is an example in the 

world of a country that did develop very quickly economically and 

didn’t exactly become democratic without some foreign imposition, 

and that was, of course, Japan in the 1930s and the ’40s. 

213 

But that is their view. Other people think pressure is going to 

do it. Some people find that counterproductive. And then there’s 

working to build multilateral and other institutions to expand the 

rule of law. 

Now, I think it’s a question of the means. We’re all agreed on the 

goals here. And there is trade-offs on each of those means. 

Dr. LAMPTON. I think your question, Commissioner, was very 

good. And I know that we have to conclude, but I do have three 

quick points here. 

One is that, yes, we’re investing a lot of dollars in China, but I 

think I heard the figure yesterday, it’s still only 1 percent of total 

U.S. FDI. 

So, if we look at total holdings of foreign direct investment, it’s 

still a modest percentage of our total. 

Secondly, you asked what risks do I see. 

And I certainly see a lot. But I think the impact of what we’ve 

heard the last two days is that China is becoming the last point 

in a lot of very strategic production chains, whether it’s computers 

or many other things. And obviously if there was disruption either 

in terms of foreign relations or domestically in China—and I share 

Dr. Shirk’s concerns about that—that could be extremely disruptive 

to the entire world financial and economic system. I think that’s a 

huge risk. 

Then the final thing, and this is sort of policy implications—is, 

how should the United States think about dealing with the risks 

we all agree are inherent in China’s rise? And there are several of 

things. First of all, we’ve got to keep our relations with the rest of 

the countries in Asia in good order. In other words, we’ve got to 

have good diplomatic relations and economic relations with everybody in Asia and not just China. Secondly, we have to keep our 

military capabilities in sound order there. I certainly think we need 

to do that. And I would agree with Dr. Krauss about the centrality 

of the U.S.-Japan Alliance just as a sort of baseline to depart from. 

Thirdly, I think all of our companies—I hope they are—are diversifying production to some extent. You don’t put all your eggs in 

one basket. We ought to attach some value to diversifying our production sites, even if we place the most emphasis on some industries in China. 

And, finally, I just would end where I think the whole logic of 

these two days has brought us and that is, ultimately we’ve got to 

keep our technological lead. And that means start with primary 

school and start educating our kids. I know I’m in higher education, but if I took any dollars and put them in education, I would 

start at the bottom of the chain, not at the top. 

Chairman ROBINSON. Well, thank you for that remark. And I 

would like to turn the proceedings over to cochairman of this field 

investigation, Ambassador Ellsworth, for some comments. 

Co-Chair ELLSWORTH. Thank you, Mr. Chairman. 

Just before I make my final comments, I want to take the opportunity to introduce to you and my fellow Commissioners a very distinguished visitor who is sitting in the front row over here. For 

many years he was the very distinguished and able president of the 

Chicago Council on Foreign Relations. He now comes out here to 

214 

UCSD once a year, and does some work as an associate professor, 

Mr. John Riley. 

John, wouldn’t you stand up so that we can recognize you and 

welcome you. 

Well, it seems to me, sitting here thinking about these days of 

dialogue and reflection on China at the behest of the Congress. The 

Congress in creating this Commission signaled that they wanted to 

understand China more deeply and more comprehensively than 

they had before. And as a former member of Congress, I can say 

I think they needed it. And, I think that we can help them with 

that. 

We live in a world in which the United States is the most powerful nation in the history of the world in almost any dimension that 

you can imagine. 

And yet, we’re going through and experiencing in our age change 

of totally unprecedented speed and depth. If you think about it, you 

can prove that to yourself in about 15 seconds of reflection. 

So it’s a kaleidoscope and it’s revolving very rapidly. And you 

here at UCSD, with your brains and your study and your scholarship and your involvement—think about Susan Shirk and her 

Track 2 involvement in the world. It’s very—been very helpful to 

us. 

And I, for one, am most grateful and glad that you did respond 

to our request for help in such a very, very strong and helpful way. 

Chairman ROBINSON. Thank you, Ambassador Ellsworth. 

And while I would certainly second those remarks and in concluding these proceedings, the Commission would be remiss if it 

didn’t express its appreciation and recognize several people from 

the University of California at San Diego, its Graduate School of 

International Relations and Pacific Studies, so-called IRPS, who 

were instrumental in making the Commission’s second field investigation what I think we’d all agree is a success. 

They did an outstanding job. They worked long hours to provide 

the logistic support and program support that enabled us to conduct this important event. 

And so with that, special thanks and appreciation for a job well 

done goes to, first and foremost, to IRPS Dean Peter Cowhey; Dr. 

Susan Shirk, again, who is the professor of political science; Portia 

Bibb, IRPS director extraordinaire, who did a magnificent job organizing this event; Olivia Knight; Barry Tradorda; USD—UCSD 

press and director of communications, Howard Lawrence; media 

services and video conference, Shannon Bradley; and the excellent 

team of technicians and operators from UCTV; Julia Engstrom, director of catering and her excellent team; and Emily Maxim, facility coordinator for the Great Hall here, which has been a delight 

to spend two days in, I can assure you. And a special thanks to my 

U.S.-China 

Commission staff, as well, for their excellent work; Carmen 

Arleth Zagursky, who did an outstanding job in preparing the briefing book for today’s and yesterday’s field investigation; my public 

affairs director and special advisor, Bob Bean; and, of course, David 

Ohrenstein, who had to fly back a little early, who is our executive 

director. So a job well done to our team, as well. 

215 

And with that, I would like to declare the second U.S.-China Economic and Security Review Commission Field Investigation closed 

and with great thanks. 

(End of proceedings.) 

(216) 

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. 

217 

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 

Statement of Francine Berman, Ph.D., Director, Super Computer Center, 

University of California, San Diego 139 

Prepared statement .......................................................................................... 142 

Statement of William Bold, Vice President, Government Affairs, 

QUALCOMM, Inc. (Telecommunications) .......................................................... 134 

Statement of Dean Peter Cowhey, Graduate School of International Relations 

and Pacific Studies, University of California, San Diego, Director of Institute on Global Conflict and Cooperation ............................................................ 9 

Opening remarks of Vice Chairman C. Richard D’Amato .................................... 3, 61 

Opening statement ........................................................................................... 4 

Statement of Kerry Dance, Ph.D., Managing Partner, Hamilton Apex Technology Ventures, LP ............................................................................................. 105 

Prepared statement .......................................................................................... 108 

Statement of Jason Dedrick, Center for Research on Information Technology 

and Organization, University of California, Irvine (Electronics Manufacturing) ................................................................................................................... 137 

Opening remarks of Commissioner Robert F. Ellsworth, Hearing Co-Chair .....5, 133 

Opening statement ........................................................................................... 7 

Statement of Richard Feinberg, Ph.D., Professor of Economics, Graduate 

School of International Relations and Pacific Studies, University of California, San Diego .................................................................................................. 61 

Prepared statement .......................................................................................... 64 

Statement of K. C. Fung, Ph.D., Professor of Economics, University of California, Santa Cruz ................................................................................................ 27 

Prepared statement .......................................................................................... 30 

Statement of Stephan Haggard, Ph.D., Professor of Political Science and 

Director of Korea-Pacific Program, Graduate School of International Relations and Pacific Studies, University of California, San Diego ........................ 61 

Prepared statement .......................................................................................... 64 

Statement of Gordon Hanson, Ph.D., Professor of Economics, Graduate School 

of International Relations and Pacific Studies, University of California, 

San Diego .............................................................................................................. 70 

Prepared statement .......................................................................................... 73 

Statement of Ellis Krauss, Ph.D., Professor of Political Science, Graduate 

School of International Relations and Pacific Studies, University of California, San Diego .................................................................................................. 173 

Prepared statement .......................................................................................... 1176 

Statement of David M. Lampton, Ph.D., Professor of Chinese and East Asian 

Studies, School of Advanced International Studies, Johns Hopkins University ......................................................................................................................... 184 

Prepared statement .......................................................................................... 188 

Statement of Greg Lucier, President/CEO, Invitrogen Corp ................................ 118 

Prepared statement .......................................................................................... 119 

Statement of Michael May, Ph.D., Professor Emeritus, Center for International Security and Arms Control, Stanford University (Energy) ............... 146 

Prepared statement .......................................................................................... 150 

Statement of Barry Naughton, Ph.D., Professor of Economics, Graduate 

School of International Relations and Pacific Studies, University of California, San Diego .................................................................................................. 19 

Prepared statement .......................................................................................... 22 

Statement of Joseph Panetta, President/CEO, BIOCOM ..................................... 116 

Opening remarks of Chairman Roger W. Robinson, Jr. ....................................... 1, 97 

Opening statement ........................................................................................... 2 

Page

II 

Statement of Scott Rozelle, Ph.D., Professor of Economic, Department of 

Agricultural and Resource Economics, University of California, Davis .......... 36 

Prepared statement .......................................................................................... 39 

Statement of Susan Shirk, Ph.D., Professor of Politcal Science, Graduate 

School of International Relations and Pacific Studies, University of California, San Diego .................................................................................................. 166 

Prepared statement .......................................................................................... 168 

Statement of Dr. Lee Zhong, MD, Ph.D., President, Elene Pharmaceutical 

Co ........................................................................................................................... 98 

Prepared statement .......................................................................................... 100