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IS CHINA PLAYING BY THE RULES? FREE TRADE,

FAIR TRADE, AND WTO COMPLIANCE

HEARING

BEFORE THE

CONGRESSIONAL-EXECUTIVE

COMMISSION ON CHINA

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

SEPTEMBER 24, 2003

Printed for the use of the Congressional-Executive Commission on China

(

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

CONGRESSIONAL-EXECUTIVE COMMISSION ON CHINA

LEGISLATIVE BRANCH COMMISSIONERS

House Senate

JIM LEACH, Iowa, Chairman

DOUG BEREUTER, Nebraska

DAVID DREIER, California

FRANK WOLF, Virginia

JOE PITTS, Pennsylvania

SANDER LEVIN, Michigan

MARCY KAPTUR, Ohio

SHERROD BROWN, Ohio

DAVID WU, Oregon

CHUCK HAGEL, Nebraska, Co-Chairman

CRAIG THOMAS, Wyoming

SAM BROWNBACK, Kansas

PAT ROBERTS, Kansas

GORDON SMITH, Oregon

MAX BAUCUS, Montana

CARL LEVIN, Michigan

DIANNE FEINSTEIN, California

BYRON DORGAN, North Dakota

EXECUTIVE BRANCH COMMISSIONERS

PAULA DOBRIANSKY, Department of State*

GRANT ALDONAS, Department of Commerce*

LORNE CRANER, Department of State*

JAMES KELLY, Department of State*

JOHN FOARDE, Staff Director

DAVID DORMAN, Deputy Staff Director

* Appointed in the 107th Congress; not yet formally appointed in the 108th

Congress.

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C O N T E N T S

Page

STATEMENTS

Opening statement of Hon. James A. Leach, a U.S. Representative from

Iowa, Chairman, Congressional-Executive Commission on China .................. 1

Levin, Hon. Sander M., a U.S. Representative from Michigan ........................... 2

Levine, Henry A., Deputy Assistant Secretary, Asia Pacific Policy, U.S. Department of Commerce, Washington, DC .......................................................... 3

Freeman III, Charles W., Deputy Assistant U.S. Trade Representative for

China, Office of the U.S. Trade Representative, Washington, DC ................... 4

Martin, Gary C., president and CEO, North American Export Grain Association, Washington, DC ........................................................................................... 29

Smith, Brad, managing director, international affairs, American Council of

Life Insurers, Washington, DC ........................................................................... 30

Hatano, Daryl, vice president of public policy, Semiconductor Industry Association, San Jose, CA ........................................................................................... 33

Primosch, William, director, international business policy, National Association of Manufacturers, Washington, DC ............................................................ 35

Lau, Lawrence J., Kwoh-Ting Li professor of economic development, Stanford

University, Stanford, CA ..................................................................................... 42

Pearson, Margaret M., professor of government and politics, University of

Maryland, College Park, MD ............................................................................... 44

Huang, Yasheng, associate professor, Sloan School of Management, Massachusetts Institute of Technology, Cambridge, MA ............................................ 47

APPENDIX

PREPARED STATEMENTS

Levine, Henry A ....................................................................................................... 58

Freeman III, Charles W .......................................................................................... 59

Martin, Gary ............................................................................................................ 63

Smith, Brad .............................................................................................................. 67

Hatano, Daryl .......................................................................................................... 138

Primosch, William ................................................................................................... 142

Lau, Lawrence J ...................................................................................................... 147

Pearson, Margaret M ............................................................................................... 153

Huang, Yasheng ....................................................................................................... 158

Leach, Hon. James A ............................................................................................... 172

Hagel, Hon. Chuck ................................................................................................... 173

Baucus, Hon. Max .................................................................................................... 174

Kaptur, Hon. Marcy ................................................................................................. 175

Levin, Hon. Sander M ............................................................................................. 176

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IS CHINA PLAYING BY THE RULES? FREE

TRADE, FAIR TRADE, AND WTO COMPLIANCE

WEDNESDAY, SEPTEMBER 24, 2003

CONGRESSIONAL-EXECUTIVE

COMMISSION ON CHINA,

Washington, DC.

The hearing was convened, pursuant to notice, at 10:20 a.m., in

room SD–419, Dirksen Senate Office Building, Representative

James A. Leach [Chairman of the Commission] presiding.

Also present: Senators Hagel, Thomas, Levin, and Dorgan; Representatives Bereuter, Dreier, Wolf, Pitts, Levin, Kaptur, Sherrod

Brown, and Wu.

Also present: Paula Dobriansky, Under Secretary for Global Affairs, U.S. Department of State.

OPENING STATEMENT OF HON. JAMES A. LEACH, A U.S. REPRESENTATIVE FROM IOWA, CHAIRMAN, CONGRESSIONALEXECUTIVE COMMISSION ON CHINA

Chairman LEACH. Let me bring this hearing to order. Chuck Hagel

will be here briefly. Let me just make a quick opening statement.

Let me say, we have a rather profound panel on a number of the

issues before us, particularly those of trade.

I just returned from a trip to the Far East and I am one that

is a very strong believer in free markets when it comes to currency

as well as commodities. I spoke very directly to Chinese officials in

this regard.

I am a believer that one of the great skewing factors in international trade today are currency relationships, and that if you do

not have a free market in currency, countries can manipulate trade

to their advantage. Also, it is implicitly to the disadvantage of

wealth of their own societies.

But trade advantages, definitely, they can do that. The great

trauma in the U.S.-Chinese relationship is the trade imbalance,

and it is something that I think this Congress is going to have to

be increasingly concerned with. That is one reason for the discussion and the group of people that we have asked to address the

Commission today.

Does anyone else want to make any opening comments? Yes,

Sandy.

[The prepared statement of Chairman Leach appears in the

appendix.]

Representative LEVIN. I just wanted to enter a statement in the

record.

2

Representative KAPTUR. May I also ask, if we wish to submit a

statement for the record, will that be permitted?

Chairman LEACH. It will absolutely be permitted, and anyone is

entitled to do that.

Representative KAPTUR. Thank you.

Chairman LEACH. And to revise and extend any other remarks

you have made as well.

Representative KAPTUR. Thank you.

[The prepared statement of Representative Kaptur appears in

the appendix.]

STATEMENT OF HON. SANDER M. LEVIN, A U.S.

REPRESENTATIVE FROM MICHIGAN

Representative LEVIN. So I will ask the same, Mr. Chairman. I

have a statement that relates to the hearing, but it also probably

somewhat reflects my feelings about the Commission’s annual report and the need for this Commission to be a center of activity.

Let me just say this, and the hearing, I think, will underline

this. The purpose of this Commission that emanated from our debate on PNTR was to help this country both engage China and to

pressure it, to put it bluntly, as it opens up, as it moves forward,

as it becomes increasingly a vital part of the global economy, and

indeed the global structure.

I think trying to meet both objectives means that we should be

direct when we have issues with China. I think the purpose of this

Commission is to focus on those issues that are basically within its

purview, human rights, including worker rights, the rule of law,

and the more this Commission can find a way to be both direct and

also engaging China, I think, the better our relationship will be.

Thank you.

[The prepared statement of Representative Levin appears in the

appendix.]

Chairman LEACH. Well, I appreciate that.

Does anyone else want to make an opening comment?

[No response.]

Chairman LEACH. Let me, before beginning, also indicate that in

discussions in China 3 or 4 weeks ago, we proposed that there are

certain types of things that the United States and China can deal

with on a different level than involved in politics or trade, and that

is the subject of culture.

With the support of the National Endowment of the Arts, we are

moving in the direction of developing an art and artists exchange

program with China that I think is intended to underscore that, on

certain levels that go beyond politics and go beyond economics,

there can be respect for each other’s societies, and that ought to be

emphasized.

So, the Commission need not necessarily formally endorse that

approach, but I think it is something that makes a lot of sense. I

just want to put that on the table as well.

At this point, if there are no more opening statements, I would

like to turn to our panelists. The first panel is composed of Charles

Freeman, who is the Deputy Assistant U.S. Trade Representative

for China, and Henry Levine, who is the Deputy Assistant Secretary of Commerce for Asia Pacific Policy.

3

We have before us in Mr. Freeman and Mr. Levine two distinguished public servants, and we welcome them. If Mr. Freeman is

not here yet, why do we not begin then with the testimony of Mr.

Levine.

STATEMENT OF HENRY A. LEVINE, DEPUTY ASSISTANT SECRETARY, ASIA PACIFIC POLICY, U.S. DEPARTMENT OF COMMERCE, WASHINGTON, DC

Mr. LEVINE. Certainly, Mr. Chairman and members of the Commission. Thank you, first, very much for inviting me to participate

in this hearing.

The Department of Commerce is committed to making sure that

China plays by the rules, and we continue a very active set of efforts in that direction in coordination with our colleagues in the

interagency process.

I will summarize my statement and will submit the full text to

the Commission.

In fact, I recently returned from China with my boss, Assistant

Secretary for Market Access and Compliance Bill Lash. On that

trip, in addition to laying the groundwork for the upcoming visit

of Secretary Evans, we also met with senior officials to discuss China’s WTO compliance and other trade issues.

Assistant Secretary Lash repeatedly stressed the need for China

to implement its WTO commitments fully and on time. I certainly

do not need for the members of this Commission to rehash the statistics which underscore the high stakes involved here, whether it

is China’s growth, the growth of its economy, its growth as an

international player in world trade, or the soaring bilateral trade

deficit.

I would, however, just note that, certainly in my job day in and

day out, I tend to focus on the problems in the economic relationship. I would note, though, that amidst those problems there are

some positives.

I think it is worth noting that since 2001, China has been by far

the fastest growing export market among our top 10 trading partners, with our exports growing something in the neighborhood of

22 percent this year between January and July. Furthermore,

China continues to account, along with the United States, for a significant part of growth in the world economy, and that is also a

plus.

As you know, I think in one particular area the Administration

has placed much emphasis on is responding to the concerns of the

U.S. manufacturing sector. Secretary Evans, in March, directed

Under Secretary Aldonas and Commerce Department staff to review the issues affecting the competitiveness of U.S. manufacturing

and outline a strategy for addressing them. The report on that subject will be released later in the fall.

In the course of developing this initiative, Commerce officials

held 20 or so roundtables across the country. And of direct relevance to this session, I would note that during the roundtable discussions no country raised more attention as a source of concern

than China.

Our manufacturers complained about rampant piracy of intellectual property, pressure to transfer technology in conjunction with

4

their investments, trade barriers, capital markets that are largely

insulated from free market principles, and so forth.

We have also heard rising concerns more broadly about the pace

and the direction of China’s WTO implementation in areas such as

transparency, distribution and trading rights, services, agriculture,

financial services, and so forth.

To ensure that China honors its commitments and to make sure

that U.S. companies can take advantage of the opportunities that

are generated, we at Commerce, working closely with our fellow

agencies, have adopted an aggressive, multi-pronged approach.

We will, for one thing, continue to target unfair trade practices

wherever they occur. We are exploring the use of new tools to expand our trade promotion efforts with regard to China, and we are

expanding our efforts to engage Chinese officials, I think, in keeping with the spirit of this Commission’s report, to help make sure

they get the rules right as they continue to write new laws and regulations in restructuring their economy.

One particular area of concern that I would flag, of course, is protection of intellectual property rights. We continue to have massive

problems in that regard. I think China can, and must, do better in

that area. We will continue to press on that issue.

One issue raised in the manufacturing roundtables, of course,

was the issue of the exchange rate of the Chinese yuan. I would

simply say on that that the Administration believes that currency

values should be set by free market forces. Secretary Snow delivered that message, of course, to the Chinese some weeks ago.

Finally, let me just say we are continuing domestic outreach as

well to prepare our companies to compete in the China market, and

we continue to press the Chinese at all levels on the issue of market access and compliance. Next up for us will be the trip to China

of Secretary Evans in October, where he will certainly work to ensure that U.S. companies face a level playing field in the China

market.

Thank you for devoting this hearing to these issues, and I look

forward to responding to your questions.

Thank you.

[The prepared statement of Mr. Levine appears in the appendix.]

Chairman LEACH. Thank you, Mr. Levine.

Mr. Freeman.

STATEMENT OF CHARLES W. FREEMAN III, DEPUTY ASSISTANT U.S. TRADE REPRESENTATIVE FOR CHINA, OFFICE OF

THE U.S. TRADE REPRESENTATIVE, WASHINGTON, DC

Mr. FREEMAN. Thank you, Mr. Chairman and members of the

Commission. I have a written statement which I would like to submit for the record, if I might, but would like to briefly summarize

some remarks, then take questions.

Briefly speaking, it has been 21 months since China has been in

the WTO. As most of you know, there were two main reasons that

we were encouraging China into the WTO.

Number one, because of the market access opportunities that

were likely to become available in one of the world’s fastest growing markets, and certainly one of the more intriguing markets, but

also to provide an independent forum at the WTO in which we

5

could mediate trade disputes without resorting to unilateral processes, unilateral action.

The other, sort of on a fundamental philosophical level, the reason we wanted to get China into the WTO, was really to begin to

encourage China to play a greater role in international organizations that play by the rules, and in so doing to encourage China

to play by the rules and, thus, to begin to implement more of a rule

of law than they previously have had.

As most of you know, China has never traditionally been a place

governed by the rule of law. There has always been a rule of man,

as it were, or woman, as the case may be. So, this is something relatively new.

Truth be told, in terms of the 15 years that it took to get China

into the WTO, the 15 years of very tough negotiations, the main

thing the Administration has learned, as in the past 21 months, is

that that 15 years was no accident.

It is extremely tough going in terms of negotiating with the Chinese post-accession to make sure that they actually fulfill their

commitments that we spent 15 years getting them to undertake.

There have been some very notable positives in terms of China’s

implementation. The first year was very much devoted to a nutsand-bolts operation in China of putting the legal regime in place

to allow for WTO implementation and compliance.

And I have to say that that process was monumental in terms

of the sheer number of new laws that they either promulgated,

passed, or amended in order to get them up to speed with WTO

implementation.

As many of us knew, year two, beginning December of last year,

would be when the rubber met the road. In the last 9 months or

so, we have really started to move beyond sheer nuts-and-bolts operations into actually trying to make sure that China lives up to

not only their commitments in the WTO by passing the laws, but

actually lives up to enforcing the laws that they have passed.

Again, that has been an occasional rough row to hoe.

I will say that a lot has been going on in China in the last 6

months that is non-trade related. They have had a major leadership change. They have had a terrifying epidemic in SARS. They

have had a fairly significant series of protests in Hong Kong that

have, I think, altered the political landscape somewhat.

And they have gone through the general process of dislocations

that any rapidly changing economy, especially an economy that has

gone from a planned to more market-oriented economy. These have

been challenges. They have not been excuses not to implement

WTO, in our view.

And, to the extent that they have been distractions for the central government away from implementation efforts, we certainly

have seen other actors in the Chinese economy step forward and

try, if not to backslide on WTO commitments, to certainly be creative and think outside of the box in ways to work around WTO

commitments.

In December 2002, and, again, every year for the next 12 years,

I believe, the Administration publishes a report to Congress on

China’s WTO implementation. Last year, we noted four major

areas of concern with China’s implementation.

6

Those were related to agriculture issues, intellectual property

rights, services, and transparency. Those continue to be the main

areas of concern, but there has been an additional area of concern

that we have noticed and that’s China’s use of value added tax policies to skew the competitive landscape for their own domestic companies, either by making the playing field slightly less than level

for our exporters or to encourage exports of products that might

otherwise not be competitive. These are significant areas, and I can

get into them in detail.

Agriculture. We have made some steps forward. We have had

some significant problems with China’s imports of soybeans, both

for genetically modified organism [GMO] reasons and for sanitary

and phytosanitary [SPS] reasons. We have made some significant

headway toward that, although we are not completely out of the

woods yet.

In terms of soybeans, we did sell a record $1.2 billion worth of

soybeans in the first 6 months of this year. That is an annual

record, so we have made some progress there.

We have had problems with our implementation of tariff rate

quotas for bulk agricultural commodities, and we pushed hard to

get those done, again, as a result of our pressure.

I do not want us pat ourselves on the back quite yet, but we certainly have exported a record amount of cotton into China in the

last 6 months. Again, we are not out of the woods with agriculture

yet.

We talk extensively about the other areas of implementation. My

time is up, I see. But, again, we are deeply engaged in pushing

these issues forward. We are making progress. It is limited, and we

are certainly frustrated at times.

We understand the frustrations of our exporters, our manufacturers, and our farmers. Our only pledge is that we will continue

to work, and we do think we will continue to make progress, but

it is a tough row to hoe. Thanks.

[The prepared statement of Mr. Freeman appears in the appendix.]

Chairman LEACH. Thank you, Mr. Freeman.

Let me just ask two quick questions. First, to Mr. Levine, from

the Commerce Department. There is the issue of free and fair trade

that all of us in American politics deal with constantly. Your office

is among the principal ones posited with the fair trade mandate

from the U.S. Government.

There is one free trade issue, though, that I would like to just

emphasize again that I spoke to very briefly earlier. That is, free

trade in currency. It strikes me that commodities are not that different from currencies.

Unless you have a free trade in currency, you have the capacity

of individual governments to, to use a verb that was used earlier,

and then also by Mr. Freeman, to skew the international landscape

of trade.

I would just like to ask whether your office has made a particular effort to speak to the currency issue and the value of the

RMB.

Mr. LEVINE. Having switched the order of our presentations,

actually I will defer to Charles Freeman from USTR.

7

Chairman LEACH. Well, I am sorry. We will go to Mr. Freeman,

but I want to ask this of the Special Trade Representatives’ Office.

Mr. FREEMAN. Yes, that is me.

Chairman LEACH. Oh, that is Mr. Freeman. Yes. Go ahead. I

apologize.

Mr. FREEMAN. I am sorry. I was delayed outside by the excellent

security here.

Chairman LEACH. I am confused myself here. Go ahead, please.

Mr. FREEMAN. We understand the seriousness of the issue. We

have heard manufacturers speak on this issue. As you know, Treasury Secretary Snow has been very active and up front with the

Chinese about the importance to the United States of the currency

issue.

As a general matter, the WTO is not what we would consider in

the ordinary course of business a mechanism to address for exchange rate policies. There are other international organizations

and multilateral organizations that do that. It is focused on commodity trade issues, generally.

That said, we certainly are taking the China currency issue very

seriously and we are very deeply engaged with both Treasury and

the rest of the Administration on the issue to make sure that what

Secretary Snow is doing and what the President is doing is carried

through.

Chairman LEACH. I appreciate that, although I do not want to

allow you to simply escape the WTO, because it could be a subsidies issue under the WTO. So, it is not exactly a non-WTO issue.

Let me then turn quickly to Mr. Levine, because other people

have questions, too. I am very concerned with some cultural types

of issues. We have been working with the National Endowment for

the Arts [NEA], with Chairman Dana Gioia, on the possibility of

an artists’ exchange and an art exchange, with a possible visit— and I do not know if it has been firmed up yet—of the Chinese premier to this country.

I am wondering if the Department is willing to think through the

prospect of a cultural agreement at that time, and have you been

thinking that through?

Mr. LEVINE. Thank you, Mr. Chairman. I believe the visit of the

premier is confirmed, and I think the Chinese foreign minister, in

town yesterday, in fact, made an announcement on that visit.

With regard to the Commerce Department, I would say that I am

not aware that we have been looking at the cultural area and cultural agreements.

I will say that, from my career, having served in China several

times and seen the cultural differences and misunderstandings, I

strongly understand the importance of those kinds of activities. We

certainly would be happy to talk with the other agencies involved,

the State Department and others, and see what the status on that

issue is.

Chairman LEACH. Very good.

Sandy.

Representative LEVIN. Thank you. Thank you for your testimony.

Let me follow up, Mr. Chairman, on your question about currency, and then I want to go on to others. Mr. Freeman, I am not

sure that your answer is going to satisfy those who are concerned

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because, as you know, article 15 of the General Agreement on Tariffs and Trade [GATT]—and it is in my opening statement that has

been submitted for the record—paragraph 4 prohibits WTO members from using exchange action to ‘‘frustrate the intent of the provisions of GATT/WTO.’’ That leaves open the possibility of our

country using one or another mechanism, including a possible section 301 effort.

I want the Administration to know that the visit of the Secretary

did not really satisfy the concerns, I think, of anybody. Indeed, that

applies not only to China, but to Japan.

Japan has been using huge amounts of its currency to buy huge

amounts of dollars. That is very open. The purpose of it is very

clear. It has a clear trade impact and purpose, and it is not a

stretch to say the same is true of the Chinese position on its currency.

So, our office has been looking at article 15.4, and provisions including section 301, and I think the Administration needs to do the

same.

Let me ask you another question, and then maybe you can comment on both. The proposal that Mr. Bereuter and I put together

some years ago now called for the creation of this Commission, but

it also created or asked that there be created an annual review.

That is covered by your testimony.

This is on page 4, I think, the transitional review mechanism

[TRM]. You say there that ‘‘the first year of the TRM was marked

by some misunderstanding between China and other members as

to expectations of China at the TRM, but communication clearly

improved. The Administration expects a smoother and more useful

transitional review mechanism effort in year two.’’ I just want to underline for you how important we consider—I

think the entire Congress considers—the effective use of that annual review.

China’s admission into WTO was a much more major event than

the accession of many other countries because of the size of its

economy and its size overall. Many of us were not happy with the

diligence, the effort that went into making that meaningful the

first year.

So, quickly, let me ask you about one specific example of where

China is not living up to its obligations, auto financing. The language was very clear in the agreement that was reached between

China and the United States, and that meant between China and

everybody else. It was part of its accession.

I do not know if you are familiar with that specific aspect. If you

are, quickly comment on it. It is one example of China’s failure to

follow through with its commitment.

Mr. FREEMAN. Thank you, Congressman Levin. Taking your

issues in turn, the Administration does not have a position currently on section 301 action, that that might or might not take

place with respect to currency. I am very happy to work with your

staff on comparing notes on how article 15 might be employed.

Representative LEVIN. Your offer is accepted.

Mr. FREEMAN. Very good.

In terms of the importance of the TRM, we agree that it is a very

important process. One of the issues, the main problem that we

9

had last year with the TRM in terms of trying to make sure that

China understood how important it was, was that China kept

claiming that the TRM was a discriminatory process, that somehow

they were being singled out for discrimination within the WTO for

special examination.

What we kept saying to China is, look, you got in under very particular circumstances. Most WTO members, when they are accepted, actually have to implement commitments in order to be WTO

members.

Because you are such an important and unique economy, you

were allowed in simply by promising to implement these commitments. So the TRM is the WTO’s way of back-checking to make

sure you are living up to those commitments.

I think, over time, that became increasingly clear. By the end of

last year, we actually had Vice Minister Long say to us, ‘‘The more

we think about it, the more we realize this is actually a very useful

exercise for us. For years we were paying Jeffrey Sachs and others

to come into our economy and tell us what we needed to do to implement reforms. Now we just go to the WTO and you tell us what

is wrong so we can implement it.’’ Whether or not you actually believe that as a result they will implement it is another question,

but at least we are now on a path where we have a better understanding. So, we anticipate it will be a bit smoother this year. We

certainly are not giving up on the process, I will tell you that.

In terms of auto finance, again, this is something that, as you

probably know, we have been very forceful with China on for quite

some time. They did promise that they would set in motion a process to create a market for auto finance, and it is 21 months and

we are still not there yet. I was there in June. They told us they

had their regulation ready to go and that it will be ready in October. So, we are waiting for October.

Again, what we have done, is they have released draft rules on

how to finance. We have commented. They have changed the rules.

And one of the things that they say to us is, ‘‘Well, we are trying

to get these out, but you guys will not let us.’’

We said, ‘‘Well, they have got to be right. You cannot just put

out any auto finance regulations. They have got to actually make

commercial sense.’’ And, to date, they have not. So, we anticipate

that the latest round of rules that they will be putting out will be

better. Will they satisfy all of the interests of our constituencies

and your constituencies? Maybe not. Maybe not. But we certainly

are making progress.

Representative LEVIN. All right. Remember, the TRM, the second

one, is up next month, right?

Mr. FREEMAN. Actually, what has happened is, there are 16 different meetings of the WTO subsidiary bodies. In fact, the Committee on Agriculture meets tomorrow morning in Geneva and does

the TRM there.

What we have done, is we have submitted a series of questions

to the Chinese. They have got a delegation from Beijing and Geneva that is there to address agricultural issues, both bilaterally and

in the WTO.

Representative LEVIN. Thank you.

Chairman LEACH. Mr. Bereuter.

10

Representative BEREUTER. Thank you, Mr. Chairman.

Thank you, gentlemen, for your testimony.

In our second panel, Gary Martin, president and CEO of the

North American Export Grain Association will present his testimony. Mr. Freeman, I would hope that you would have a chance,

with other members of the USTR, to look carefully at it.

It talks about the situation we face today with respect to our agricultural exports—uncertainty regarding biotech regulations,

issuance of permanent safety certificates for biotech products, labeling and information requirements on meat and poultry products

that increase export costs without enhancing food safety, and finally the lack of Chinese adherence to the agreement on the application of sanitary and phytosanitary measures.

All of these things seem to put us at a substantial disadvantage

until we have progress in those areas on this particular sector for

export base. I do not know if you have any reaction to that, but

I think those are significant problems that need to be addressed.

Mr. FREEMAN. Congressman Bereuter, thanks very much. As Mr.

Martin and others know, agriculture has been one of our abiding

concerns and abiding focuses of the Administration since December

2001. All of those issues that you raised are right at the top of our

agenda.

On biotech issues, we are waiting for the permanent safety certificates to be issued. They have extended the interim regulations

until April 2004. But, again, we are waiting for the final shoe to

drop there.

The labeling requirements, again, are a continued problem that

we have been pushing. It is not simply a problem of labeling. It is

that the labeling is so inconsistent, so it is hard to actually put

your thumb on it. SPS regulations are a continued bane. We just

had four soybean shippers that were threatened with a ban on

their exports for alleged SPS issues that, in our view, just ‘‘ain’t

so.’’

So, apparently we have gone into technical talks with them on

that issue. What they have said is, as long as those technical talks

are proceeding, they will not implement the ban.

But, again, what all these actions do, is they do create a cloud

over the marketplace and they do make trade that much more difficult. That probably adds some extra cost to our exports, and that

is something we really want to avoid.

Representative BEREUTER. It does, indeed.

A week ago today, I had a chance to express my concerns to Secretary Evans at a party caucus of the House. My concern related

to the fact that the European Union, it seems to me, is outstripping

the United States in dramatic ways with respect to their work with

the Chinese authorities.

They are in China and they are assisting, for their own benefit,

the Chinese to write the standards for manufactured products.

Those standards oftentimes are not—in fact, usually are not—the

same as we have in this country.

Therefore, the long-term impact of their success in working with

the Chinese is going to dramatically hurt our manufacturing base.

I think my advice to him is, we cannot protect our interest in the

Chinese markets on the cheap.

11

The USTR is a very lean agency; I hope lean and mean in a positive sense. But the Commerce Department, the USDA, and the

State Department have to be in greater numbers on the scene in

Beijing and in China, and we do not have enough people to do the

job in that location.

The impact is going to be very detrimental in the short term and

increasingly detrimental. I want to give that message to you once

more, to the Administration, that you cannot do this on the cheap.

You have to be there with people that are well-trained, and now

is the critical time. We do not have any time to lose.

Would you like to respond?

Mr. LEVINE. Yes, I would. Thank you.

With regard to the specific issue of standards, I absolutely could

not agree more. I know Secretary Evans, of course, has attached

a tremendous amount of importance on the issue of standards. It

really is a strategic choke point, in a sense.

If we get the standards issues wrong, as you suggest, if in fact

the EU or others promulgate standards which effectively shut our

products out of the market, the results, indeed, would be tremendously damaging.

For that reason, let me just say we have been undertaking a very

active program at Commerce, and in fact are continuing to build

on that program. Just this week, the Chinese standards organization was in town and signed an MOU with the National Institute

of Standards and Technology [NIST] for further cooperation.

We have coming up several planned seminars and workshops.

We are talking with the U.S. private standards development organizations about finding a way to increase or to have some representation for them actually on the ground in China.

We are, in a word, trying to make very strong efforts in this

area, and will continue to do so. I agree completely, this really is

a critical issue for us.

Representative BEREUTER. Well, as a representative concerned

about the export base in my own district and State, and our national concerns, I could not help but raise these issues, these commercial export issues, with you.

Coming to the mandate of this Commission, in the area of corporate social responsibility, we have three particular findings. I

will just mention two of them very briefly for you and the people

gathered here.

The first, contract factories that are not owned by U.S. companies produce many of the products that China exports to the

United States. Many factories that sell nearly all of their products

to U.S. consumers receive only indirect consumer pressure to provide adequate working conditions for their employees, directly to

human rights kinds of issues.

Second, despite the good efforts of some U.S. companies sourcing

from China, current efforts by these companies have not significantly improved working conditions in Chinese contract factories.

These companies are beginning to recognize that auditing is not

enough to assure acceptable working conditions.

Now, we have to have an impact on what happens in China

through our American commercial enterprises and the contract facVerDate 11-MAY-2000 10:53 Dec 19, 2003 Jkt 000000 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 90833.TXT China1 PsN: China1
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tories that so most of the work in producing those products that

they in turn export to us.

I would hope that we are having the same kind of interest on the

part of the European Union and Japan, for example, that they have

that kind of social responsibility, but I am not confident that they

do.

I have been told, Mr. Freeman, from what seems to be a reliable

source, that one-third of the exports from China to the United

States today are to Wal-Mart. Do you think that is within the

realm of possibility? By value.

Mr. FREEMAN. I have heard similar statistics. I have heard that

Wal-Mart does import a tremendous amount from China. I know

that Wal-Mart is also very focused on market access in China, and

they are one of the fastest growing retail operations there. So,

there is some two- way trade there, but they do a tremendous

amount of business there. That is true.

Representative BEREUTER. Well, it must be a very large amount.

It is a third, perhaps, or maybe more. Somewhere around that, I

would guess. They are a behemoth in this country in the retail sector and are rolling over their competition. They are the largest grocer in the country now. You can buy everything at Wal-Mart, as

you know.

It seems to me, Mr. Chairman, that if we had an opportunity for

Wal-Mart to come and talk to us, we could, by influencing the policy of one company, dramatically impact the contract factors in

China and the working conditions in which the Chinese work, and

also the competitive situation that our own producers face in this

country.

I would like to suggest that maybe the place we focus some attention on social responsibility is on the giant. If we can get good

cooperation and movement on their part, it not only sets a good

model for the rest of the Americans and hopefully for the Europeans and Japanese. At least we could get some early results if we

can convince them that this is an important priority they should

have, and that the dollar is not everything.

I welcome any final comments you might have on the question,

but those are the things I wanted to put on the record at this point,

Mr. Chairman.

Chairman LEACH. Do either of you want to comment further on

Mr. Bereuter’s incredibly thoughtful observations?

Mr. LEVINE. I would just add that, on the corporate social responsibility side, Secretary Evans, as I think you may know, has attached enormous importance, and I think in the context of his

upcoming visit to China we are looking at events, in fact, that can

highlight his commitment and the U.S. commitment in this area.

So, that is also something that I know he feels very strongly about,

and we are working as best we can in that area. Thank you.

Chairman LEACH. Ms. Kaptur.

Senator LEVIN. Mr. Chairman? Just very quickly.

Chairman LEACH. Yes, Senator. Would that be all right?

Representative KAPTUR. I would be pleased to yield to my champion, the Senator from Michigan.

13

Chairman LEACH. Why do we not do it this way, then. Since no

Senator has been recognized yet, why do we not recognize you, Senator.

Senator LEVIN. I do not want to go out of order. I just ask you

to yield for 1 minute.

Representative KAPTUR. I would be pleased to yield.

Chairman LEACH. Please. Yes, of course.

Senator LEVIN. On the report, I am in support.

Chairman LEACH. Thank you.

Senator LEVIN. I want to thank the Commission and want to

express my strong support for including the question of currency

manipulation by China in our deliberations and to find ways to do

that in assisting with our mandate. There are ways to do it, I believe, in reference to the WTO.

My brother made reference to Chinese currency manipulation in

his opening statement, and the impact it has on our exports, and

that it is a subsidy to Chinese exports. This is an important issue

that needs to be included as this Commission proceeds next year.

I want to thank the Chair, and thank you, Congresswoman Kaptur,

for allowing me to intervene.

Representative KAPTUR. I would yield for you any time.

Chairman LEACH. I would ask the gentleman to yield briefly

from his intervention and simply stress that I think this is a seminal issue in our trade relations. I also think that there is a point

that has to be stressed from the perspective of the U.S. Congress.

Many in China are saying, what are we doing suggesting a precise, new peg for their RMB? I would stress, we are not. What we

are suggesting is that there ought to be a free trade in currency

and that the market would determine the value. That is different

than saying their RMB ought to be revalued 2 percent, 8 percent,

40 percent. It simply is, let the market determine the value.

I would also stress that, from a manufacturing perspective, there

are clear and obvious implications. But from a total wealth perspective, a strong currency from China’s view has some real pluses

for their society in terms of their capacity to buy foreign goods and

to buy more of their own goods.

This is not an effort of an American society that thinks it is

being totally disadvantaged to achieve something process-specific,

it is simply to press a principle, and the principle is free trade and

fair trade. That is very different than saying a precise, pegged

point.

Senator LEVIN. I thank the Chairman for that. It is clear that

what China is doing is manipulating the currency to advantage

their exports and disadvantage our exports, and that is not allowed

by the GATT.

The GATT does not permit, under article 15, WTO members from

taking action to frustrate the GATT provisions. That is what China

is doing in pegging its currency the way it does, and it is having

a severe effect.

Both management and labor, companies and unions, are together

in this country, to try to stop China from taking these actions and

doing that manipulation which so disadvantages our exports and

advantages their exports. It costs us jobs, especially in the manuVerDate 11-MAY-2000 10:53 Dec 19, 2003 Jkt 000000 PO 00000 Frm 00017 Fmt 6633 Sfmt 6633 90833.TXT China1 PsN: China1
14

facturing area, where now over 2.5 million manufacturing jobs

have been lost in the last couple of years.

So, it is important that we include the issue of Chinese currency

manipulation in the next report, and find ways to include this issue

as we discuss the WTO.

Chairman LEACH. Fair enough. At the risk of presumption, I

want to make a concluding point to emphasize the concern of people in other societies and publics. When governments intervene to

skew their currency, private markets are much larger. When inevitable changes occur, it is public treasuries that lose sums of money.

So, if you take the Japanese intervention which your brother

raised, if there is a movement of the Japanese currency, let us say,

of a 20 percent direction and the Japanese government has intervened to the tune of, let us say, $300 billion, the public in Japan

loses 20 percent times $300 billion, which is a $60 billion loss to

the public of Japan.

Japan is moving in this direction, partly because other countries

have skewed their currency relationships. But it causes huge losses

of public funds when you have these pegged currencies that governments intervene to try to prop up. That will inevitably be the case

in China.

Senator LEVIN. I admire the Chairman’s optimism in attempting

to persuade the public in China and Japan that it is not in their

interest to do what they are doing. I admire you no end for that

effort. I had given up on that a long time ago.

I think it is particularly important that we let them know that

we are not going to tolerate it. It is not in our interests that they

be allowed to do what they have been doing in China and Japan

for such a long time. I would add what I think is our principal

need, but I must say, again, the Chairman is absolutely right, that

it is not in their interest, ultimately, either.

But I am not so sure that they are going to see it that way. In

the meantime, I think we have got to make it clear to them what

is clearly not in our interest, that they continue to do the manipulation that China, Japan, and others have done for too long without

contest on our part.

Chairman LEACH. As usual, the Senator from Michigan is more

profound than I am.

Ms. Kaptur.

Representative KAPTUR. Thank you, Mr. Chairman. Just to follow up with an observation. The anemic U.S. growth rate has been

reduced by a third because of our ongoing and growing trade deficits with the world, China now being our leading trading—what

would we call it—deficit partner, Japan being No. 2.

I remember, as a young, naive Congresswoman coming in here

21 years ago and being told, ‘‘Oh, Congresswoman, it is only a currency problem. At that point, Japan was the leading trading partner with the United States. The problem is not that they manage

their trade, Congresswoman. The problem is the yen. When we get

the right yen/dollar relationship, we will have a balance.’’ Wrong.

It will not happen because it is not a free market with Japan. It

is a managed market with Japan. It does not matter if it is 150

yen to the dollar or 98. We continue to sustain $50 billion trade

15

deficits with that country every year, largely in the automotive sector. That is No. 1.

And, believe me, we have written bills, we have tried to get market opening. In 1983, less than 3 percent of Japan’s market were

automobiles or parts from anywhere else in the world. In 2003, the

same number.

So you can fiddle around in a side show all you want, but in the

end the trade deficit is your measure and it has been failure, after

failure, after failure of this country actually moving those balances

in our favor.

Now we face China and, again, a managed trade situation. Under

your gentlemen’s watch, our trade deficit with China has doubled.

It has doubled. Now, you would not get a passing grade of A in any

school if those numbers kept going up from the standpoint of the

people of the United States.

Now, you can spend all the time in the world concentrating on

the currency exchange. But let me tell you, when you have managed markets, it will not matter because Japan is our model of

what has happened, and we have continued to erode production.

I guess there is an assumption by some that America will just

cash out everything: since the year 2003, now, 3 million more manufacturing jobs; in the agricultural sector, 50 cents of every U.S.

farm dollar, now Federal subsidy, only to hold the farm credit system together or we would have a collapse like the 1930s.

Something is fundamentally wrong with the trade accounts. It is

at the highest of policy levels. I was looking at how long you gentlemen have served in your current positions, and we are very happy

that you are there.

But you are not going to succeed because the fundamental policy

is wrong. The United States is essentially cashing out her wealth.

The reciprocal of that trade deficit over 20 years is the amount of

our public weal.

The Chairman has talked about the public side, that it is now

owned by foreign interests, nearly half, with China being our largest creditor and Japan No. 2.

We are paying them interest now. Why would they want to reduce their currency exchange with us when they are getting pretty

good interest rates at the moment? So, we are living on borrowed

capital. That is all we are doing right now in this country.

I would like to ask you gentlemen a question. In the last year,

how many times have each of you traveled to China to deal with

these issues that we are talking about here this morning? I am just

curious.

Mr. FREEMAN. I have been, in the last year, probably five times.

Representative KAPTUR. Good.

Mr. LEVINE. I just assumed my current portfolio handling China

and other parts of Asia only 4 months ago, I guess. I have made

two trips to China in that time, and will be going out again next

month with Secretary Evans.

Representative KAPTUR. I know those are very wearying trips.

I would like to propose this. I do not know if we do it through

this group or I do it separately, but here is an example.

Huffy Bicycle had 2,000 people employed in Ohio manufacturing

the best bicycles America had. Two thousand workers who have all

16

now lost their jobs. They earned a living wage. Was it the highest

wage in the world? No. They had health benefits. They produced

a fine product.

That Huffy Bicycle is now being manufactured in China. I would

like to visit that facility in China with you gentlemen, and I would

like to take some of the people that used to work at that plant in

Ohio with us.

I would like to compare the working conditions of the people who

now manufacture those bicycles and I would like to compare the

quality of those bicycles compared to what the people in Ohio used

to make.

Those bicycles come back to places like Wal-Mart and K-Mart.

And you know what? The price did not go down. The workers in

China make about 10 cents an hour. I think it is important for

American to understand the differential on which certain global

interests are trading.

They are trading on the exploitation of workers who work for

starvation wages. They are trading on environmental conditions

where we are leaving cesspools around the earth. There are certain

wealthy players in the international realm who take great advantage of this situation.

Until we fly in the face of that, we are never going to balance

these trade accounts. Meanwhile, jobs across this country and the

wealth of this country, more than money, but the manufacturing

and the agricultural wealth, continues to get cashed out.

I really want to go with you. But I do not want to go to some

abstraction about some currency exchange that is going to be

changed because we have some kind of belief that the world really

operates in free markets.

It does not. We have managed trade. When you have countries

that follow a managed trade regimen, you get trade deficits. We

end up being the dump market of the world, and shame on us.

We also do not make lasting friends around the earth. So, to me

these trade deficits are unsustainable. I really want to go with you,

but I want to take the people from my area. Let us look at this

right in the eye. This Commission is a way to do that. Congressman Levin asked for something more tangible. Let us make it more

tangible.

I wanted to ask a question. That is, do you believe that the trade

deficits that we are now experiencing with China are sustainable

for the health of this economy inside the boundaries of the United

States?

Mr. FREEMAN. Well, Congresswoman, thank you for that. On the

question of going to China, I think that would be very useful, for

a couple of reasons.

Representative KAPTUR. Great.

Mr. FREEMAN. First of all, I think not only would it be useful for

your trip and the trip with former workers at Huffy to see the conditions there, it also would be very useful for the workers in China

to exchange views and know what they are missing out on, perhaps. So, I think it would be a very useful trip and I would be

happy to recommend to Ambassador Zoellick that that trip take

place.

Representative KAPTUR. Thank you.

17

Mr. FREEMAN. With respect to the trade deficit question, I am

not an economist. I am just a humble market access person. I will

say that, in terms of the deficit with China, it is the largest growing percentage of our overall deficit. It is about 22 percent of our

overall $463 billion deficit.

But it is slightly confusing, because one of the problems is that

a lot of the things that we used to buy from places like Indonesia,

Malaysia, and Thailand have shifted to China. So, actually, China’s

deficit has increased, while the deficits from those other places

have come down.

The other problem is that our deficit has increased recently because our exports have come way down. About half the new growth

in deficits has resulted from our exports having decreased. Interestingly, that is not the case with China. While our exports to the

rest of the world have decreased about 8 percent, in the last few

years exports to China have increased about 65 percent. China is

our fastest growing market.

So, the growth in the deficit with China is certainly something

that we are particularly focused on and concerned about, but there

are other issues that are at play. One is that China is taking up

a new share all on its own of the overall deficit. So, again, it is a

complicated issue. But I think the fundamental thing that we

would like to get to, is to make sure that the playing field is fair.

Chairman LEACH. If I could interrupt, briefly. We have a vote on

the House floor. We have about 10 minutes left on the vote on the

defense appropriations conference report. I think we are obligated

to recess, with the exception of the Senate members. Senator,

would you like to continue?

Senator DORGAN. Mr. Chairman, I would.

Chairman LEACH. Would that be all right with you, Marcy? Then

we will return to you when we come back.

Senator DORGAN. Mr. Chairman, if you do not mind, let me inquire. We have Secretary Rumsfeld downstairs in the Appropriations Committee.

Chairman LEACH. Sure.

Senator DORGAN. Let me inquire for a few minutes, and then I

will put it in recess.

Chairman LEACH. I think that would be very appropriate.

Senator DORGAN. Thank you very much.

Chairman LEACH. Then we will put you in full charge, and then

recess and we will return. Thank you.

Senator DORGAN. I had forgotten how much I admire the passion

of Congresswoman Kaptur, I must say, before she leaves. The passion on this issue is very important.

I regret that you will miss my questions, Mr. Chairman, and the

answers from Mr. Freeman and Mr. Levine. But I will try to make

notes.

First of all, let me thank both of you for your service. I appreciate people coming to public service and offering themselves for

public service. I know that you work in an area that is very important to this country.

I share some of the same concerns that Congresswoman Kaptur

does. I think our trade policy is a colossal mess, getting worse, not

better. Much, much worse. I see things happening in international

18

trade that make no sense at all. I will describe just a couple of

them. I do want to ask you a couple of questions.

The China situation is very interesting to me because I was on

the House Ways and Means Committee many years ago. I believe

our deficit with China then was about $10 billion a year. I told my

colleagues who were pushing a policy, this is going to explode on

us. Indeed, it has. There was a $103 billion deficit last year with

China.

I come at this from the standpoint of, particularly, agriculture,

but I am very concerned about manufacturing jobs and the export

of jobs from our country.

Let me ask a couple of questions. Mr. Freeman, you would expect

I will ask questions about wheat. We produce a great deal of

wheat. It was not too long ago, a couple of decades ago, we were

selling $500 million worth of wheat in a year to China. Now it is

1/20th of that, $25 million.

What I want to ask you about specifically is, my frustration is,

we never taken action. We do not have a backbone. We do not have

the nerve, the will, to stand up and say, this is wrong and we are

going to fight for the right result. We just do not do it. We are sort

of squishy on all these issues.

There was a fellow named Bruce Quinn who left USTR. He was

an associate of yours who, on March 17th of this year, was speaking at a wheat industry meeting. There was a reporter there, and

the reporter reported what he said.

In an explosive fit of candor, Mr. Quinn said that the Trade Policy Review Group in this Administration, which includes all the

major Federal agencies involved in these issues, had given the

USTR the ‘‘green light’’ to proceed with a case against China for

blocking sales of U.S. wheat to China.

So, someone from USTR, 1 week before he left USTR—now, that

is an important point. He was actually leaving, going to go out the

door, and in a fit of candor told the wheat industry meeting that

the Trade Policy Review Group had given a ‘‘green light’’ to USTR

to file a trade action against China for blocking the sales of U.S.

wheat. What he said was that USTR was deciding not to do that

because it was thought this would be an ‘‘in-your-face’’ thing to do

to China.

I wrote to every one of the Federal agencies that belonged to the

Trade Policy Review Group and asked them, ‘‘Is this the case? Did

you, in fact, as a Trade Policy Review Group, give the green light

to USTR to take action against China with respect to blocking

wheat sales? ’’

They all wrote back. No one denied giving the green light. Some

outright, in fact, said they had done so. If I showed you the letters,

it is kind of a mishmash of wonderful comments.

But it appears to me that someone had decided at some point in

the Trade Policy Review Group to take action here, and the Trade

Policy Review Group had actually said, here is the green light, take

action against China for blocking wheat sales. No action was taken.

Can you give me some background on that? Was there, in fact,

that discussion? Was there a decision that the green light was

given to USTR to take action? If so, why was action not taken

against China for blocking U.S. wheat sales to China?

19

Mr. FREEMAN. Senator, thanks very much. If my buddy Bruce

were here to respond, I am sure he would. Bruce Quinn left our

office. He is actually a Commerce employee. He is now stationed

in Chennai—formerly Madras. He’s the senior commercial officer

there.

What he said, basically—well, I will not paraphrase what he

said, but let me tell you what essentially happened. TRQs. Tariff

rate quotas. China, for some time now, has not implemented the

system of tariff rate quotas to the extent that we think they ought

to have. Tariff rate quotas cover a variety of things, cotton, corn,

soybean oil, and wheat.

One of the issues was that we have had four problems with tariff

rate quotas with China, four problems with China’s administration

of tariff rate quotas. First of all, they have a catch-22 licensing situation. You need to have a contract in order to get a tariff rate

quota allocation, but you cannot get a tariff rate quota allocation

unless you have a contract. There is a real lack of transparency.

When they do allocate a TRQ, we do not know who is getting it,

so it is very difficult for our traders to find out who has got the

right to buy wheat, corn, or whatever it might be.

There also was a subquota for processing trade, which, in other

words, meant that part of the tariff rate quota that was set aside

had to be processed, which, in our view, did not conform with WTO

standards.

Finally, they were allocating tariff rate quotas in very small

numbers, 2 or 3 metric tons, which, if you know, trying to ship 2

or 3 metric tons to China does not make commercial sense. The

cost does not make sense.

So what we did is that Al Johnson, who is our chief agricultural

negotiator, Ambassador Zoellick, and others got together with Secretary Veneman and said, ‘‘We have been pushing this issue for a

while. We are ready to go. We want to push forward on this, and

we are looking at a WTO option here.’’ But, as you know, like any legal process, WTO action is not a

magic bullet. It takes time to resolve. While you are going through

the process, how much wheat are you selling? How much cotton are

you selling? How much corn are you selling?

So the question is, ‘‘Can we work out with China bilaterally a

resolution to these issues or are we forced to go directly to the

WTO? Are we going to say, the heck with it, let us go forward? ’’

The issue was that the Trade Policy Review Group got together

and said, ‘‘Look, Ambassador Johnson, if you cannot work it out

with the Chinese, go for it.’’ Ambassador Johnson went to China.

I went with him. We worked it out.

We have got two of our key issues resolved. We have got a third

they said they have resolved, and a fourth they say that you will

see that it is resolved by January when we allocate quota for 2004.

So, right now, again, out of the process of doing that, we have sold

a heck of a lot of cotton this year.

Now, wheat, as you probably know, has been relatively high

priced in this country for the last year or so because of conditions,

and in China the price has been relatively low.

Senator DORGAN. Well, you do not own a farm then if you think

wheat is high-priced.

20

Mr. FREEMAN. No, I know. I understand. But the issue is that

the market price in China has been relatively low. This year, it is

going to be high. So, now we can see whether they are actually

going to implement on wheat, and that is going to be the key thing

for us in January.

Senator DORGAN. But the Chinese Government, I understand,

has decided that only 10 percent of the licenses are available to private importers, 90 percent reserved for the Chinese Government,

about. Therefore, the Chinese Government decides whether they

will or will not buy American wheat. Is that not correct?

Mr. FREEMAN. There is a certain percentage that has been reserved for State traders.

Senator DORGAN. Is it 90 percent?

Mr. FREEMAN. I do not know what the exact number is. I certainly can get it for you.

Senator DORGAN. Well, I am told it is 90 percent.

Mr. FREEMAN. I can get it for you.

Senator DORGAN. That is more than a certain percent.

Mr. FREEMAN. I can figure it out.

Senator DORGAN. Well, let me ask this. We did the bilateral with

China, and as you know we did not vote on that. Had we been able

to vote on it, I certainly would have voted ‘‘no,’’ for many reasons.

I will give you automobile trade, just for one. Our negotiators,

whoever they were, sat down and said to the Chinese, after a long

phase-in we will agree to have a tariff on U.S. cars going to China

that is 10 times higher than we would have as a tariff on Chinese

cars into the U.S. market.

I do not have the foggiest idea, when you have a $100 billion

trade deficit with a country, how you sit down and decide that, on

auto trade, they should have a tariff that is 10 times higher and

sanction that in a bilateral.

I think it is incompetent. I do not know who negotiated that, but

I think it is fundamentally incompetent. Aside from that, when we

did the bilateral, with respect to wheat, there was established an

8.5 million metric ton TRQ level.

There was this euphoria by some. Not me. What a wonderful opportunity to ship wheat to China. Then the agriculture minister of

China went to Guangzhou, and then the South China Morning Post

had this to say. The minister said, ‘‘You know that 8.5 million metric tons? That is just theory. It does not mean that is what is going

to happen here.’’ It seems to me that if you follow the trail of evidence, that you

come to an inescapable conclusion that even Inspector Clouseau

could reach here, that the trade with China is fundamentally unfair and ought to require us to take action.

I understand your point, Mr. Freeman. You say, ‘‘Well, we could

take action, but of what value would that be if we are still negotiating? ’’ My question is why are we negotiating in the immediate

shadow of having reached an agreement? One would expect, with

a country like China in which we are a cash cow for China’s hard

currency needs with this huge imbalance of trade, one would expect

that, when we reach a bilateral, you would not have to, 6 months,

12 months, or 18 months later worry about whether there is compliance. You would, by God, expect there is compliance.

21

So, on behalf of wheat farmers, I would just say to you, if somebody has been given the green light to go take action against China

on behalf of our wheat farmers, I want you to stand up and take

action on behalf of our wheat farmers and say to China, you have

an obligation to let wheat into China. You have an obligation to

buy our wheat.

So you say, well, our wheat is expensive. I will tell you, the price

of wheat is not anywhere close to being expensive if you are raising

it and selling it. It does not meet the cost of production.

I do not want to hear the Chinese tell us that we have expensive

wheat. That is nonsense. We have a lot of wheat they ought to be

buying, and they are not buying it because they explicitly, in my

judgment, want to keep it out of the Chinese marketplace.

And if they want to ship us all their trinkets and their trousers

and their tennis shoes and their shirts, good for them. But our

market ought to be a sponge for other goods from other countries

only if their market is open to us, and only if trade is fair.

Frankly, our farmers understand that trade with China is not

fair because they are keeping our wheat out. I really want you to

file an action, take action. You are saying to me, I think, today, Mr.

Freeman, that we will see the final result of these negotiations by

January.

But I will tell you something, both on the Ways and Means Committee in the House and also in the Commerce Committee here in

the Senate, for, I guess, now, 20 years, I have been hearing people

promise that it will be next January, or next month, or next week,

or just over the next hill, or just around the next curve, that somebody is going to see some of the good happen on behalf of American

producers. But nothing good has happened with respect to China.

I will make one other point. I do not mean for this to be painful

for you to listen to. You indicated that China is our fastest growing

market, but that is a statistic that is almost irrelevant. That is like

me saying, on average, Bill Gates and I are worth $32 billion between the two of us. So what? Is it true? Sure, probably. But I have

nothing.

The fastest growing market? Take a look at the imbalance and

take a look at the sector-by-sector analysis, and then understand

the passion of my colleague, Congresswoman Kaptur, whose Huffy

bicycles are not produced in this country, they are produced elsewhere. Why? Because of free trade? Absolutely not. Because of

other sets of circumstances that create what we think is a fundamental unfairness in our marketplace.

So, let me come back and say that I want both of you to succeed.

This is not a criticism of this Administration. You could put a

blindfold on and listen to the murmurs of Trade Representative officials from Democrat and Republican administrations for 20 years

and you could not tell which administration was speaking, with one

single exception, and that was a momentary lapse during Mickey

Kantor’s term when we slapped TRQs on Canada and had a significant impact on some grain issues with Canada. Otherwise, it all

sounds the same. Meanwhile, the problem gets worse and worse

and worse.

22

So, having said all that, which is extraordinarily therapeutic for

me this early in the day, I want to ask you to be willing to take

action. We have trade dispute resolutions for a very specific reason.

That is, when somebody is not complying, then we have a right.

We have a right to go after them and say, ‘‘Our market is open to

you, but your market must be open to us, and it is not. Sell your

trinkets in Zambia.’’

Well, you might want to respond to some of that. But are you

willing to take some action next week? [Laughter.]

Mr. FREEMAN. I am going to demur on that. I will say that I do

not think that there is any reticence about taking action in the Administration. The idea, though, of course, is to make progress.

While I can tell you, having gone through my own share of frustrations, that it would be somewhat therapeutic for me to take it next

week, too.

But I will say that your passion and leadership on this is well

known, not only within the Administration, but in China. Your

voice is something that China needs to hear, too.

I have had conversations with your staff at some point about the

usefulness of your taking a group of wheat farmers from your state

or elsewhere and making sure that the Chinese understand how

important it is, not just for the Administration, but to wheat farmers and to the Senator from North Dakota to actually buy North

Dakota wheat. I think that is a message that they need to hear.

Senator DORGAN. Yes. Well, I will take farmers to China if we

go on a boat filled with wheat. [Laughter.]

And you promise, that they will buy it when we get there. I will

take farmers to China, but only to sell wheat.

Mr. FREEMAN. I will see what I can do. [Laughter.]

Senator DORGAN. I took a farmer to the Canadian border 1 day

in a 12-year-old orange truck, and we could not get 200 bushels of

durham into Canada. All the way to the border, we were met by

18-wheelers hauling Canadian grain south. So, we are a little sore

about some of these one-way trade agreements,

And I will certainly take you up on your offer, but we want that

offer to include wheat moving to China in significant quantities.

Well, Mr. Freeman, I want both you and Mr. Levine to succeed.

One other question. Market access compliance. That is you, Mr.

Levine? Both of you?

Mr. LEVINE. We share the responsibility, I would say. It is in the

title of my position, actually.

Senator DORGAN. You are with USTR and you are with Commerce. We have Commerce/State/Justice appropriations coming to

the floor, and I am fiendishly working on how I might improve that

for you all.

Can you tell me how many in Commerce, working on market access compliance, are tasked with the issue of dealing with China,

specifically China? How many people are involved in dealing with

the China trade issue?

Mr. LEVINE. Yes, Senator. In fact, it is a number that has grown

substantially over the last, I guess it is, 5 or so years. Our China

office in the market access and compliance part of Commerce has

grown from 7 staff to a total of 18 today.

23

In addition, of course, within China itself we have something in

excess of 90 Commerce Department staff. That includes the Commercial Service, with a strong trade promotion focus.

Included in that number we have two market access officers

based at our Embassy in Beijing. These are both American lawyers

hired out of the private sector. They have extensive experience representing U.S. companies in China. They both speak Chinese. They

are working full-time at our Embassy in support of market access.

Senator DORGAN. You talked about promoting trade. My interest

is in requiring compliance. So are you mixing the two with respect

to these 18 people?

Mr. LEVINE. No. The 18 people are market access and compliance, yes, then the two at our Embassy in Beijing as well, supported by Chinese employees.

Senator DORGAN. How many of those 18 are stationed here in

Washington?

Mr. LEVINE. All of the 18 are here in Washington, plus we have

two focused 100 percent on market access and compliance at our

Embassy in Beijing.

Senator DORGAN. In fact, my colleague has returned from the

House. Let me just finish. I know others will return in a moment.

But I am going to be dealing with this issue on the floor during

the Commerce/State/Justice appropriations process. We have grown

from 7 to 18.

In fact, if you take a look at China, Japan, Europe, Canada, Mexico, Korea, which are major areas of, I think, significant trade challenges, I think we dramatically underfund the resources that are

necessary to really deal with market access compliance and enforcement of trade laws.

Now, it does not pay to have much of our resources devoted to

enforcement if nobody is willing to enforce anything, if we are just

going to all sit around and play cards and sip warm tea and talk

soothing things about how wonderful we all are.

It does not mean anything to me. What means something to me

is if we are going to ask other countries to live up to their obligations in international trade. We never have. There has been no evidence that that has ever been a priority.

Well, I have had some really interesting opportunities to spend

some time. You went all the way to the U.S. House and back

again? Time flies when you are enjoying it.

Let me thank both of you for being here. I will pursue this further.

Chairman LEACH. Senator, I will tell you, one of the longest distances in America is between the U.S. Senate and the U.S. House.

[Laughter.]

Senator DORGAN. Especially now.

Chairman LEACH. We have managed to return, and we are very

appreciative of your hospitality on these shores. If you want more

time, you are welcome to have it.

Senator DORGAN. I thought you were talking about the construction, but you were actually talking about elections.

Chairman LEACH. No, I am talking about the ethereal psychological distances that have to be traversed. [Laughter.]

Senator DORGAN. We are like one. [Laughter.]

24

Chairman LEACH. But we are observers, and as observers, we

want you to know we are very impressed with your career, sir.

Thank you.

Ms. Kaptur, you were in the middle of your questions.

Representative KAPTUR. Yes, Mr. Chairman. I am sorry I missed

Senator Dorgan’s questioning. I know I would have been enlightened by it.

I wanted to continue with a line of questioning on how much

trade deficit for the United States is sustainable, with China or

with any country, indeed. As you look toward the next year, what

are your goals to reduce the deficit?

Do you have a target, an Administration target to move this

trade deficit down? Do you have specific targets? I would be very

interested in that.

Then I wanted to ask either of you gentlemen, do you view China

as a democratic country? Then, finally, what is the average wage

in the manufacturing and in the agricultural sector in China?

Mr. LEVINE. I will follow up and respond further, Representative

Kaptur. Let me say, first, I am not aware of an Administration target in terms of the deficit. Again, certainly our focus remains on

making sure that China complies with its commitments, that we

remove market access barriers so we can increase our exports and,

further, take the steps necessary to enforce our trade laws and deal

with unfairly traded imports from China.

So, in terms of the policy thrust we are very much focused on

that, but I am not aware of any particular target on the deficit.

If I could actually back up for one moment to your earlier comments and say, first of all, that I would be delighted also to help

facilitate and go along on your visit.

I will say that, in a previous incarnation as the U.S. Consul General in Shanghai, I had the pleasure of arranging a visit—this goes

back a couple of years now—by Senators Lautenberg and Harkin

to a contract apparel factory located outside of Shanghai. Again, I

think that was worthwhile, and I would be delighted again to work

on this effort as well.

Representative KAPTUR. Thank you. I really appreciate that. I

am sure some of my colleagues would have similar interests.

Mr. LEVINE. With regard to the question, no, China is not a

democratic country by any means. It is not a democracy. With regard to the average wage numbers, I think I would have to get

back to you with the specifics on that.

Representative KAPTUR. Do you have a feel for it? Is it over a

dollar an hour?

Mr. LEVINE. I have heard sort of varying numbers in different

parts of the country and so forth. Certainly, it is a fraction of comparable wages here in the United States in any comparable job. I

would feel better about getting back to you with really some more

solid data.

Representative KAPTUR. I really thank you for that. I notice that,

in terms of U.S. exports to China, certain machinery and electrical

goods are gaining in ascendancy. I would like to posit the theory,

as we look at what has happened in other places, those are the machines to manufacture the goods that will then displace more jobs

25

here in the United States. It is an intermediary step that occurs

in the displacement process.

Yes, Mr. Freeman? Did you want to comment on the sustainability of this level of trade deficit, whether you are aware of

whether USTR has a goal for this year to reduce the trade deficit

with China?

Mr. FREEMAN. We do not have a numeric target, at least that I

am aware of. Again, I think I will leave it to the economists to decide what is sustainable and what is not. I am just not qualified

to comment.

Again, our focus is market access, making sure that we increase

both the openness of China’s market and that China plays by the

rules in international trade, and hope that, through the combination of that, that that will take care of issues like deficits, and so

forth.

I do not know what the average wage is. As Mr. Levine was suggesting, there are different parts of China that have radically different standards of living. The coast is increasingly a wealthier

part of the country and, therefore, has a higher standard of living.

The internal part of China is extraordinarily poor, where I think

a dollar a day is probably significantly more than the average

wage.

Representative KAPTUR. Would you guess that a third or more of

the exports to the United States come from the Guangdong Province area?

Mr. FREEMAN. It is up there, yes. Shanghai is probably close.

Mr. LEVINE. I think it is possible, from that area. Again, I think

we would be probably better served, and you would be better

served, if we really take a hard look and get you solid data.

My recollection was that, at one time, almost 40 percent of China’s exports were coming out of the southern part of China, including

Guangdong Province. But, as I say, we would be happy to update

those statistics and get back to you with some solid numbers.

Representative KAPTUR. I thank you very much for that.

Mr. Freeman, do you believe China is a democratic country?

Mr. FREEMAN. No, China is the farthest thing from a democratic

country. I am sure it will be some time before they do become

democratic.

Representative KAPTUR. Mr. Chairman, if you would just let me

close with this comment. As we watch the fall of the Soviet Union

and the transformation of internal economies in Russia, Ukraine,

Belarus, et cetera, it has been very interesting to watch the politics

and the economics proceed.

I think one of my concerns with a country that is undemocratic

is, as Wal-Mart, as Mr. Bereuter referenced, conducts business in

China, whom are we empowering economically and what connection does that have to the politics?

When you put aside politics as an important ingredient in relationships and you concentrate only on economics, what kind of a

world are you really producing? So, I do have some questions in my

own mind as to who, politically and economically, we are empowering inside China, an undemocratic country.

As people purchase goods in the United States and those dollars

flow back to Chinese interests, whom are we empowering and what

26

kind of system will we bequeath to our children and grandchildren?

It is a question I would let hang out there, but a deep concern.

We thank you very much for your appearance today.

Mr. Chairman, thank you so much for allowing me to complete

my questioning.

Chairman LEACH. Well, thank you very much, Ms. Kaptur.

Mr. Wolf, do you have any questions?

Representative WOLF. I want to follow up. We cannot sustain it.

The National Association of Manufacturers [NAM] has predicted

that the trade deficit with China will be roughly, I think—well, I

do not want to say a figure that is not accurate. They have been

by to see me.

I think they said it would be roughly $600 billion, and the deficit

with trade with China in 2005 or 2006—I will submit it for the

record—would be something like $430 billion. We cannot sustain

that. I mean, no country has ever, every sustained that.

Two, I was glad to see you say that it is not a democracy. It is

not.

[The information follows:]

The National Association of Manufacturers has predicted that next year—2004—

the deficit will be $125 billion and will increase to $330 billion in 5 years.

Representative WOLF. I wanted to ask you a couple of questions.

Following up on what Ms. Kaptur said, would you give us within

the next week, because this thing has been on my mind—and I listened to an interview with a woman in China. Her salary was $17

a month. She worked six days a week, 12 hours a day. One lady

who was the supervisor, or the boss, if you will, was making $27

a month.

So, could you give us, both of you, maybe, a side-by-side, hourly

wages, wage-an-hour, overtime, EPA. Just take everything that our

people have to go with, EPA, family leave, the number of vacations,

and then compare it with what China has. Because there have

been a lot of stories, and I think Ms. Kaptur is right. When I heard

her interviewed, I thought the salary was higher, but she felt that

she was doing very well at $17 a month.

She talked about the conditions, and this being much better than

she would have ever expected. Yet, at $17 a month, that is probably about an hour and a half for a Wrangler jeans manufacturer

somewhere down in southern Virginia. I think they made $10.50,

$11 an hour.

So, if we could get that side-by-side, perhaps by the end of the

week on all of the issues, health care, anything and everything an

American manufacturer has to do in comparison.

The only other question that I have is, and I want to thank the

Administration for it. It looks like you are finally catching the vision about how serious this is. For a long period of time, I think

the Administration was not focusing.

But with the job loss, and I think Secretary Evans’ speech in Detroit the other day, and the comments and relationships that we

have had with the Department, both of your departments over the

last couple of days, I do want to thank you for the fact that I think

you now understand this problem and are aggressively being involved in it and trying to reverse it.

27

If China were to comply in an honest, ethical, moral, decent way

by the objective man test to the WTO, what percentage of the problem would go away?

Mr. FREEMAN. I do not even want to hazard a guess there. I

think what you would see, is you would start to see a reversal of

fortune here. Not a complete reversal of fortune, but I think you

would see the growth at least slowed in the deficit and probably

reversed.

Representative WOLF. Has anyone, from a scholarly basis, done

a piece objectively saying where China was not in compliance? I

mean, we know there are so many cases. It just goes on and on and

on.

Mr. FREEMAN. I do not think there has been one comprehensive

academic study of non-compliance. There have been some in the

area of agriculture. To be quite frank, I think the report that we

do to Congress every year is probably about as comprehensive a

survey of China’s compliance as we would get.

Representative WOLF. In the State/Commerce/Justice bill, we are

setting up what we call Team B. Ronald Reagan, during the days

of the Soviet Union, set up a Team B to challenge Team A, if you

will, on the strength of the Soviet Union.

We are trying to set up a mechanism where GAO and others

can—I think the more you are pulling in people from outside to test

you, to make sure that what you are doing is exactly accurate, because there is a lot of talent out there, and I do not think the Administration ought to feel funny about taking advice from people

outside. But I think the more you are going outside, particularly

with the mood shifting in a country, the better it would be.

I guess, if you could maybe just submit for the Commission in

a summary form some of the areas that you believe that China is

not in compliance with the WTO, and major areas that, if they did

come into compliance, what the impact of that may very well be on

this problem.

The last issue that Ms. Kaptur addressed, did you have a projection, either of you, of what the trade deficit with China will be? It

was $104 billion last year. This year, it is going to be about $120

billion. What are your projections, if nothing changes, for the year

2005, which is just 2 years from now? Do you have any projection

for that yet? Well, you really have to do that, though.

Mr. FREEMAN. I know that the Council of Economic Advisers

[CEA] does some studies on that.

Representative WOLF. Well, if you could give the Commission a

projection. I know it is difficult to go in the out years to 2010, but

if you would take the current circumstances the way they are and

give us a prediction of what you think it will be in the year 2005.

And the last question is, what impact is this now having, not

only on manufacturing, but on the high-tech industry? I am beginning to see more stories about the high-tech. What is the impact

that you see China having on the high-tech business community?

That is my question.

Mr. FREEMAN. Well, there are two things. I mean, one, if you are

looking strictly at semiconductors, for example, China’s value

added tax policy actually encourages domestic production of semiconductors in China.

28

What that does is encourage migration of our production to

China. That is something which we don’t want to see. Again, we

have been talking to China extensively about the WTO consistency

of their VAT rebate policies.

What we want to do is make sure China understands not only

that the policy of VAT rebates may be WTO inconsistent, but there

actually are multiple good reasons to maintain imports from the

United States of semiconductors for purely economic reasons. So,

that is where we are on semiconductors.

I will say that one of the areas that we are profoundly concerned

about and which China really needs to stop the words and start

producing deeds, is on intellectual property rights, which has impacted not just the high-tech area, but everything from auto parts

to Zippo lighters. I mean, if we can make it, they can fake it, quite

frankly.

And one of the things that we need to see is China taking steps

to not just produce a WTO-consistent IPR regime, a legal regime,

but actually make sure that they are creating deterrent-level criminal penalties that put IPR infringers behind bars.

Unless that happens, we are going to continue to see a lot of IPR

violations, IPR problems, for everything from semiconductor masking piracy to reverse engineering of our high-tech products taking

place in China.

It is something that China’s leadership right now seems to understand. At least, they are telling us that they understand the role

of IPR in a mature economy. But, very frankly, once you get past

that top leadership, it gets real murky.

That is why the leadership has to step up and say, all right, we

are going to put criminal penalties in place that are going to put

some of you guys behind bars. And we do not care who you are,

you are going behind bars if you infringe IPR. That is something

that Ambassador Zoellick has been very focused on, frankly.

Representative WOLF. Thank you, Mr. Chairman.

Chairman LEACH. Thank you.

Are there further questions of this panel?

[No response.]

Chairman LEACH. If not, we want to thank you all very much,

and we will turn to the next panel.

Panel 2 is composed of Gary Martin, who is president and CEO

of the North American Grain Export Association. Mr. Martin

proudly served in the Administration of George H.W. Bush at the

U.S. Department of Agriculture, and in the Clinton Administration

as advisor to the Special Ambassador to the former Soviet Union.

Mr. Brad Smith is currently managing director for international

affairs, American Council of Life Insurers. Mr. Daryl Hatano is the

vice president of public policy with the Semiconductor Industry

Association [SIA].

Mr. William Primosch is director of the international business

policy in the International Economic Affairs Department of the National Association of Manufacturers [NAM]. He is a former career

diplomat of the U.S. Department of State. Unless there is a prior

agreement with the panel, we will just go in the order in which you

were introduced. Is there any disagreement with that?

[No response.]

29

Chairman LEACH. All right. Then we will begin with you, Mr.

Martin.

STATEMENT OF GARY MARTIN, PRESIDENT AND CEO, NORTH

AMERICAN EXPORT GRAIN ASSOCIATION, WASHINGTON, DC

Mr. MARTIN. Thank you, Mr. Chairman. I will speak today, as

have previous speakers with their comments and the discussion so

far today, about agricultural market access issues. That is the entire focus of my association’s work, and indeed a passion of my personal career.

Additionally, I ask that you accept my formal comments into the

record. I understand that time is short, so I will be as brief as possible in making my comments. I think that you have already seen

a demonstration of the importance of the Chinese market and the

importance of success in that market.

Chairman LEACH. If I could interrupt for a second. Without objection, the full statements of all panel members will be placed in

the record, and you can proceed as you see fit. Please, go ahead.

Mr. MARTIN. Thank you.

I think you have seen a demonstration of the importance of the

Chinese market and China’s successful implementation of its WTO

commitments. The importance to agriculture and the agricultural

economy here in the United States cannot be overstated. It is a

dominant market force globally. The Chinese agricultural and food

system is very important to us.

We have had some successes. Investment has been directed to

China. Trade has been directed to China. I would point out that,

in the last 5 years, we have seen a quadrupling of agricultural exports to China, much of that as a result of the accession to the

WTO.

However, we still have some difficulties. In my testimony, I get

into quite a bit of detail about those issues. But I want to point

out, in particular, six key issues, and then address some recommendations for progress along these lines. Several of these

issues have been mentioned already this morning, so I will keep it

short.

The uncertainty regarding biotech regulations is, indeed, a continuing issue. The work of the Administration, and particularly the

interest of President Bush in this regard, has resulted in placing

us very close to resolution, but we need to close the deal in that

regard.

Labeling on meat and poultry products is certainly a major issue

for us. Labeling that really does not enhance food safety is a considerable problem in China. The Chinese adherence to the SPS

agreement in the WTO, remains very much an open question.

Continuing attempts by the Chinese customs administration to

manage trade, particularly import trade, via quarantine measures

is a continuing issue and a priority of ours, as well as export subsidies, particularly for corn, and the range of problems we have already heard discussed on the tariff rate quota system.

Our association today asks that the United States aggressively

focus attention and improve Chinese compliance with the WTO in

three particular areas. We think this is the most bang for the buck

and provides the most opportunity in the shortest time.

30

First, the regulatory practices of the Chinese State Administration of Quality Supervision, Inspection, and Quarantine [AQSIQ].

Second, complete and final elimination of agricultural export subsidies. Third, improvements in the implementation of the agricultural TRQ system.

With respect to AQSIQ practices, current practices are unworkable. We have three recommendations in that regard. The agency

should restrict its activities to science-based standards that comply

with WTO and international convention; the agency should approve

import permit requests in a timely and commercially realistic manner;

and the agency should ensure that its operations are transparent.

With regard to agricultural export subsidies, the problem of export subsidies for corn persists in particular. Subsidies have resulted in lost sales of U.S. products in key markets: in South

Korea, Malaysia, Indonesia, and even Japan.

With regard to agricultural export subsidies, we have two recommendations. China should formally and fully account for the discrepancy between domestic and export corn prices. Finally, China

should immediately meet its WTO commitment and proceed to

eliminate officially supported mechanisms that permit exports at

lower than domestic prices.

Our final focus has been discussed quite a bit this morning: the

agricultural tariff rate quota issue. There are new regulations and

new practice being developed now in China that we need to review

to ensure that China is honoring its TRQ obligations in a way that

provides for transparency and commercially feasible quotas. That is

important and needs to be implemented immediately. Again, it was

part of their requirements in December 2002.

In summary, much has been accomplished since China’s accession to the WTO with regard to its commitments related to agricultural trade. However, U.S. expectations are for additional and more

timely progress. The U.S. and Chinese Governments have demonstrated an ability to resolve some outstanding issues.

Given the importance of several unresolved concerns to both

China, the United States, and global markets, a renewed commitment and additional effort by the United States, China, and the

WTO are warranted. Thank you.

[The prepared statement of Mr. Martin appears in the appendix.]

Chairman LEACH. Thank you very much.

Mr. Smith.

STATEMENT OF BRAD SMITH, MANAGING DIRECTOR, INTERNATIONAL AFFAIRS, AMERICAN COUNCIL OF LIFE INSURERS, WASHINGTON, DC

Mr. SMITH. Thank you, Mr. Chairman, for the opportunity to testify.

I would first like to start off by saying that one of the reasons

that the American Council of Life Insurers [ACLI], and our industry counterparts, mainly led by our property/casualty counterpart,

the American Insurance Association, were such strong supporters

of PNTR for China was because the accession package, consisting

of a schedule of specific commitments and the working party report, were extremely good market access and national treatment

commitments for our industry.

31

Having just returned from Cancun and looking at some of the offers on the table from other major emerging markets that are already members of the WTO, and the level of commitments that we

are now trying to get them to implement, expectations are very

high.

Having done several bilateral implementation measures in insurance liberalization agreements the United States has negotiated

with Japan and Korea, we did realize, however, going into this

process that no agreement is self-implementing. In the implementation phase, constant monitoring and enforcement pressure is the

most important aspect in actually realizing the commercial benefits

of any agreement.

Starting this process, I would like to commend the U.S. Trade

Representative [USTR], the Commerce, Treasury, and State Departments, and many interested Members of Congress who have

helped us establish an ongoing dialog with the Chinese Insurance

Regulatory Commission [CIRC] which is tasked with drafting the

implementing regulations.

Since China’s entry into the WTO, CIRC has drafted five regulations. The first several were very general and did not give a great

deal of specificity on how China would live up to its WTO commitments. The U.S. Government, led by USTR and Commerce, has

gone back to the Chinese repeatedly on these issues with questions

that we have generated and that have been generated by consultants we have retained in China. Our goal has been to try to take

away the corners, get positive confirmation on how China will implement her commitments, then proceed, get licensed, and begin

operations.

We have several member companies that have operated in China

that consider the process exemplary, and that their communications with CIRC are very positive. We have others that are somewhat frustrated with the process. I would just say that, over the

last 2 years since the beginning of implementation, we have noticed

positive progress in the area of transparency.

The last two regulations that China implemented to address our

specific questions with regard to capitalization and branching requirements which we had considered a major market access barrier

actually lowered the requirements by two-thirds. Once they are finally adopted and enter into force, we feel they will largely address

our concerns on capitalization restrictions in the Chinese market.

Another notable development in the recent release of draft regulations was that they actually were released in draft. The CIRC

posted them on its Web site and invited public comment. We provided comments within the time they allotted. We have translated

this into Chinese, sent it to USTR, as well as other U.S. Government agencies. Our hope is that, by the end of the year, we will

be able to continue a dialog with the CIRC to clarify our concerns

and questions.

This has actually worked in the past. Our capitalization issue,

we believe, was addressed because of a meeting that USTR and the

Commerce Department at the U.S. Embassy in Beijing were able

to schedule as a face-to-face between our industry and our regulators in Beijing in December of last year.

We are hopeful and cautiously optimistic that by——

32

Chairman LEACH. If I could interrupt just briefly, Mr. Smith.

Mr. SMITH. Sure.

Chairman LEACH. Co-Chairman Hagel has come. He is in a meeting with Mr. Bremer on the Iraqi issue and he wants to indicate

a vote, and maybe make a comment, if you would like. Go ahead.

Senator HAGEL. Mr. Chairman, thank you very much.

I am, first, sorry that I have missed the panel and the meeting.

But, as the Chairman noted, we have had Ambassador Bremer before the Foreign Relations Committee the last 21⁄2 hours, and we

go right back into another hearing and I have to go preside.

So, I know they are lame excuses, but, nonetheless, that is where

I have been, and I am sorry to miss this. I will obviously catch up

along the way and appreciate, as we all do, your presence here,

your testimony, your insights.

I think there is little question of the importance of what we are

trying to do and what this organization has been about the last 2

years. It is critical that we continue to get your input and your insights into so many of these issues that will have immense consequences in the future for America’s relationship with China and

all aspects of the world. So, thank you very much for the time that

you have taken to come and offer your insights and thoughts.

Mr. Chairman, thank you very much.

Chairman LEACH. Well, thank you. Thank you for your support

and for taking time to leave your committee. As you know, Senator

Hagel, it is my personal view that about half of the wisdom in the

U.S. Senate resides on your shoulders. Thank you for coming.

Senator HAGEL. You are far too generous. But he is from Iowa,

so that is probably some explanation. But, thank you very much.

And for Congressman Wolf’s attention to this Commission over the

years. Frank, thank you. You have been a very significant part of

this and your contributions have been important. We appreciate it.

Representative WOLF. Thank you. If I could say, I like seeing you

on television because you always tell the truth. When the show is

over, you always know precisely where you stand. A lot of times I

agree with you, so I wanted to comment. I saw you at the summit.

Senator HAGEL. Thank you.

Chairman LEACH. All right. Thank you, sir.

Please proceed, Mr. Smith.

Mr. SMITH. Thank you. I would conclude just by saying that we

think this is the beginning of a process. We have had extensive bilateral negotiations or a follow-on on implementation through

USTR and other U.S. Government agencies.

We have also worked to mobilize a coalition of our competition

overseas. The European, Japanese, and South Korean insurers that

have operations in China have similar concerns.

At the Geneva transitional review mechanism meetings and the

Committee on Trade and Financial Services, the United States has

found itself in an admirable position of leading a charge of five or

six governments that all have similar questions on insurance

matters.

To the extent that we can continue to coordinate the pressure

from international counterpart organizations to try to make sure

that China fully implements its commitments, we think that just

adds strength to the effort.

33

As I say, this is the beginning of the process. We will look forward to getting back to this Commission and to interested Members of Congress on the outcome. We have some regulations that

we just commented on in July and August. They are fundamental

to establishing the criteria under which companies can expand in

China. We have provided detailed comments and we sincerely hope

that those comments are taken into consideration. We look forward

to reporting to you on that by the end of the year. Thank you.

[The prepared statement of Mr. Smith appears in the appendix.]

Chairman LEACH. Good. Thank you, Mr. Smith.

Mr. Hatano.

STATEMENT OF DARYL HATANO, VICE PRESIDENT OF PUBLIC

POLICY, SEMICONDUCTOR INDUSTRY ASSOCIATION, SAN

JOSE, CA

Mr. HATANO. Good afternoon. My name is Daryl Hatano, and I

am testifying today on behalf of the $70 billion U.S. semiconductor

industry, which is America’s largest manufacturing industry.

This morning I would like to follow-up on two points that Deputy

Assistant USTR Charles Freeman made in answer to your question, Mr. Wolf, with regard to the value added tax rebate program

on semiconductors in China and on intellectual property enforcement.

But before turning to these issues, I would like to first note the

progress that has been made since China joined the WTO. Over 80

percent of China’s chip market is met by imports. The U.S. industry was a major beneficiary of China’s elimination of semiconductor

tariffs last year.

The United States has also made progress in resolving two WTO

implementation issues, one related to a trade barrier that had prevented China’s participation in the Information Technology Agreement, and the other related to product coverage under China’s

semiconductor intellectual property protection laws.

SIA appreciates the efforts that USTR and the U.S. and Chinese

Governments have made to resolve those two issues, and we are

hopeful that the momentum that we have built from that can carry

over into the value added tax rebate program and the intellectual

property issues that I would like to turn to next.

China currently imposes a value added tax [VAT] of 17 percent

on semiconductors, regardless of whether they are imports or domestic production. However, China will rebate to domestic producers the amount of that VAT that is above 3 percent of sales. So,

basically it is a discriminatory policy that favors domestic production over imports.

This discrimination violates GATT article 3, which prohibits

countries from imposing taxes on imported products that are greater than those imposed on domestic products.

To comply with the WTO, SIA believes that the best policy for

both U.S. export interests, as well as China’s economic development, is for China to lower the VAT on imports; that is, to have

the same VAT level for both domestic production as well as imports

at the lower level that they have announced.

Many in Congress agree with our conclusion. Earlier this year,

members of both the House and the Senate, including four memVerDate 11-MAY-2000 10:53 Dec 19, 2003 Jkt 000000 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 90833.TXT China1 PsN: China1
34

bers of this Commission, sent letters to Ambassador Zoellick urging

him to vigorously insist that China abide by its WTO commitments

and lower its VAT on all semiconductors.

This is also not just a U.S. issue. In May, the CEOs of the chip

industries in the United States, Japan, Korea, Europe, and Taiwan

came together under the banner of the World Semiconductor Council and proclaimed that China’s VAT policy ‘‘has the effect of limiting market access, distorting patterns of trade and investment,

and negating the benefits China promised to provide when it joined

the WTO.’’ As a result of this attention, China has formed a research group

to reexamine the VAT issue. In my recent meetings in China, we

sensed a willingness in some quarters to explore alternatives with

the United States. However, in other quarters there was continued

skepticism that changes were necessary. The U.S. Government

must continue to insist that China quickly come into compliance

with its WTO obligations.

The second key issue I would like to cover today is the enforcement of intellectual property. SIA is aware of numerous reports of

IP violations in China. In one case, an SIA member company found

that Chinese firms were making identical copies of its chips and

data sheets and selling it under the Chinese companies’ names.

The chips were essentially photocopies of the U.S. design, and even

included the same unused circuits that the U.S. company had put

on the chip to reserve space for future product development.

The Chinese firms that engage in piracy are typically thinly capitalized companies that rely on foundries to actually manufacture

the product. These foundries are the ones that are able to afford

the multi-billion dollar investments that are required in our industry.

The court system in China is still developing, and U.S. firms are

concerned about the fairness of their procedures. China also has

administrative enforcement mechanisms, but these are largely untested. The Chinese Government has expressed a willingness to

work with the United States to improve its IP enforcement.

It is worth noting that IP enforcement is critical, not only to U.S.

firms doing business in China, but also in China’s self-interest, as

it will encourage foreign high-tech investment in China, as well as

encouraging local innovation in China.

SIA urges the U.S. Government to devote the necessary resources to address the many technical issues in China’s IP enforcement procedures.

China is a large and growing market. While the challenge of the

transition from a planned to a market economy is immense, we are

encouraged by China’s progress and the commitment demonstrated

by Chinese Government officials in our recent meetings. We look

forward to continuing to work with the U.S. Government to further

China’s movement toward implementing its WTO commitments.

Thank you.

[The prepared statement of Mr. Hatano appears in the appendix.]

Chairman LEACH. Well, thank you, Mr. Hatano. I think you have

not only set a record for staying within the time limit, but for

someone with so many degrees, including an MBA and a law deVerDate 11-MAY-2000 10:53 Dec 19, 2003 Jkt 000000 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 90833.TXT China1 PsN: China1
35

gree, that is particularly impressive. Usually, the longer the number of degrees, the more discursive. So, thank you.

Mr. Primosch.

STATEMENT OF WILLIAM PRIMOSCH, DIRECTOR, INTERNATIONAL BUSINESS POLICY, NATIONAL ASSOCIATION OF

MANUFACTURERS, WASHINGTON, DC

Mr. PRIMOSCH. Thank you, Mr. Chairman, for giving the National Association of Manufacturers [NAM] an opportunity to testify on a subject of great interest to our members.

I can tell you that we hear more from our members about trade

with China than with any other foreign country. In fact, Mr. Chairman, at our meetings of the NAM board yesterday afternoon and

this morning, China trade concerns dominated our discussions.

Trade with China is of immense importance for U.S. manufacturers because China is both a large, rapidly growing market for U.S.

products, and at the same time a fierce competitor in the United

States and global marketplaces.

As China concludes its second year as a WTO member, however,

its compliance record is decidedly mixed. The NAM has received far

more complaints about Chinese trade practices this year than in

the previous year.

In a recent survey, our members identified a variety of policies

that have provided Chinese exporters with unfair trade advantages

and created significant non-tariff barriers that hindered market access, and many have been mentioned already by my colleagues and

by members of the Commission.

At the top of the list is currency manipulation and China’s deliberately undervalued currency. In the view of many manufacturers,

China’s undervalued currency is the single most important factor

driving the growing trade imbalance between the United States

and China.

Economists have estimated that China’s currency could be undervalued by 40 percent or more. As of July, China had accumulated

more than $350 billion in foreign exchange reserves. This is far in

excess of what IMF analysis indicates is necessary, and a clear indication of currency undervaluation.

Another concern relates to subsidized exports. We continue to receive reports from different industries that Chinese products are

being sold in the United States at prices so low, they could not

cover the cost of raw materials and shipping, much less full production and marketing costs. These reports suggest the possibility of

widespread use of subsidies, either direct, or very likely indirect.

A third major concern was mentioned by other panelists, and

that relates to counterfeiting and intellectual property rights violations. Violations of trademarks through product counterfeiting is

rampant on a truly massive scale, and is within the knowledge and

purview of both local and national government authorities.

While Chinese laws on intellectual property rights protection

have improved considerably, the lack of effective enforcement of

IPR protection remains a serious problem.

Other problems were noted by our panelists, and they have also

been noted to us at the NAM: value added tax discrimination; problems with standards and the application of the CCC Quality Mark

36

System; failure to implement automobile financing regulations that

were promised under the membership agreement, and resistance to

allowing U.S. companies to have export and import rights as required under market access pledges.

In short, Mr. Chairman, we see a variety of unfair practices that

are impeding U.S. exports to China and providing Chinese products

with competitive advantages in the U.S. market.

The Commission has asked for policy recommendations for

changes, things that could be done better. We have a few suggestions. But, first, we would like to say that U.S. agencies, particularly the Commerce Department, Treasury Department, and USTR

have been making good efforts to advance U.S. trade interests and

deal with a lot of these problems.

The scope of the challenges, however, requires a much larger

scale effort than currently exists. The NAM recommends the following five-point action plan:

First, compliance with WTO trade rules and market access commitments are critical for creating a level playing field. Commerce

and USTR need additional staff to monitor, and more importantly

investigate, WTO compliance concerns. Current resources are not

adequate to do the job right.

Second, we must continue to press China to end the manipulation of its currency and to allow the yuan/dollar exchange rate to

be determined by market forces. Secretary Snow’s visit was an excellent start, but we need to keep the pressure on China and we

need to involve our other trade partners, particularly the G–7.

The NAM is prepared to support a section 301 trade complaint

in concert with other members of the Sound Dollar Coalition as a

way of underscoring the seriousness of this matter.

Third, we must effectively address subsidized and non-market

based production. Fourth, we must take firm action to end China’s

rampant counterfeiting and violations of intellectual property

rights and use trade action when necessary.

Finally, and I would like to thank Congressman Wolf for his support and interest in this, we need to support a much larger scale

public-private sector trade promotion effort to increase U.S. exports

to China.

In 2003, China will become the world’s third largest importer,

with $380 billion in imports. We will only get 8 percent of that import market. We can do better than that. Thank you, Mr. Chairman, for giving me the opportunity to testify.

[The prepared statement of Mr. Primosch appears in the appendix.]

Chairman LEACH. Thank you, Mr. Primosch.

I want to just ask one question, and it is of you, Mr. Primosch.

It relates to your very last phrase and the 8 percent issue of U.S.

participation in exports to China.

Does the NAM, or does anyone in our government, keep statistics

on the relationship of the U.S. trade deficit in contrast, most particularly with the European Union, but with other parts of the

world? For example, we have about a $400 billion deficit this last

year in trade. What is the EU’s? What is the relationship of their

exports and imports?

It strikes me, there are two very interesting general statistics.

One, is the statistic of what China imports from us relative to what

37

we import from them. Second, what China imports from us relative

to comparable groupings of societies. For example, the EU, in relationship to what the EU imports from them.

Do you have those figures?

Mr. PRIMOSCH. I have some of the statistics, Mr. Chairman.

Chairman LEACH. Go ahead.

Mr. PRIMOSCH. I think you have raised a very interesting point.

The European Union exports about 50 percent more to China than

the United States. The European Union imports considerably less

from China than the United States. I do not have that exact figure.

But what is interesting is that, I think, particularly in manufactured goods and in machinery, for example, the European Union

exports about $7 billion more than we do. It is not quite clear why

they are able to do that.

Someone earlier in our discussion mentioned standards.

Chairman LEACH. Mr. Bereuter. Yes.

Mr. PRIMOSCH. Is this because European governments support

their businesses more? That is an issue. I think there is more support by their governments of export promotion. That is an issue.

They are much more supportive of their companies in China. And

I think we also have to admit that many European companies, and

particularly smaller companies, are more export oriented. They

perhaps put a little more effort into it. That is something that U.S.

manufacturers can learn from that as well. So, I think it is a variety of factors.

Chairman LEACH. Yes. To the degree that there is a managed

trade element—and there is—now, there is a free aspect of trade

with China that goes on, and we understand that. There is a managed element that goes on and we somewhat understand that.

Should we be expecting China to be importing comparably at least

as much from us as they do the EU? Is that a reasonable expectation of the United States?

Mr. PRIMOSCH. I think that is a reasonable expectation. Particularly now with the decline of the dollar against the euro, we would

expect to see more exports to China from the United States in a

lot of these manufactured goods areas than from the European

Union. So, yes, I think you are correct on that, sir.

Chairman LEACH. Thank you very much.

Sandy.

Representative LEVIN. Thank you. Thank you for your excellent

testimony.

Let me just say a word about the WTO compliance and the use

of the annual review. Each of you come from somewhat different

sectors. Do you feel there is enough interaction between yourselves

and our government as it prepares for these annual reviews? The

second one is now under way, or will soon be under way.

It is one forum, an important forum, for us to raise these issues,

to press these issues, to secure support from other countries so it

is not simply the United States and China.

So, what are your thoughts about that? Is there enough back and

forth? Are you enough of a participant? You think you are?

Mr. MARTIN. With respect to the WTO annual review?

Representative LEVIN. Yes. Exactly.

38

Mr. MARTIN. Yes. I think that the interaction between the agricultural community, USTR, and USDA, in particular, is sufficient.

They have identified the issues clearly and have taken them forward to the WTO process. I do not see any gaps in understanding

what the issues are and where we’re at.

Representative LEVIN. But how about the intensity of our pressing them?

Mr. MARTIN. I think that is a matter of resource allocation. I

agree with the previous comments, there are not enough resources

there today to deal with the size of the market that China represents.

Representative LEVIN. All right.

Mr. PRIMOSCH. If I could make an additional comment. I do think

we have very good cooperation with both the Commerce Department and USTR. They do welcome our input, and they make themselves available.

In fact, there will be a hearing on October 3—probably many of

us will be testifying there. We have provided a detailed report on

China’s compliance to USTR, and we will have an opportunity to

make additional comments at the hearing.

However, I do think that many of the issues that we have identified are resource-intensive issues. When you get into issues like

standards or intellectual property rights, for example, of automobile parts that are being counterfeited, you need to do investigative work and really pin down where this is happening and follow

through. Clearly, there are not enough resources for that kind of

intensive investigation and follow-up, in our view.

Representative LEVIN. That is important. Mr. Wolf, my guess is,

has taken note. We should not short-change this annual review. We

work to have it occur and we have got to make it meaningful. I

think China needs to realize that it is an important forum, and it

can be a constructive effort. So, that is point one.

Second, I just want to mention, in terms of the currency issue,

I just want to refer again to article 15, paragraph 4, because there

are some who question whether there is any relationship to the

WTO.

That article 15, paragraph 4 prohibits WTO members from using

‘‘exchange action’’ to ‘‘frustrate the intent of the provisions of the

WTO.’’ So, it seems to me there is a clear basis for our utilizing

measures within the trade ambit relating to currency valuation.

The last point regarding counterfeiting of intellectual property. I

think when people hear that, they think mostly about movies. That

is the most common one. Because when you go to Beijing, as I

have, you walk down the street and pretty soon somebody says,

‘‘Would you like to buy a CD, now a DVD? ’’

But is it not a larger problem than that? Does it not relate to

manufacturing and the products that are made? Do any of you

want to comment on that?

Mr. HATANO. Well, it is also a semiconductor problem. We have

the sort of problems where they are copying semiconductor chips.

We can use the term ‘‘counterfeiting,’’ but from a legal perspective

it can be a violation of the semiconductor mask work law, similar

to what we have here in the United States, because it is illegal to

just copy the designs of a chip. It is also a violation of copyright

39

law because they are often copying our data sheets and other

things that go with that, and any software that is accompanying

the chip. It is also a violation of trademarks, because they are selling it under our name.

There is also a consumer fraud element because effectively what

they are doing is trying to get the customers to think that it is a

U.S. product with U.S. reliability behind it. So, there are a lot of

aspects to it and it is something that is one of our highest priorities.

Representative LEVIN. Yes, Mr. Primosch.

Mr. PRIMOSCH. May I just add to that? Congressman, you are absolutely right. This is not just a problem with films or CDs. Virtually every manufactured product or consumer good has been

counterfeited in China, from footwear and health care products to

pharmaceuticals.

I have even heard from a representative of the auto industry of

an entire automobile that was counterfeited. This is a very serious

problem for a wide range of manufactured products and it has

many dimensions.

For example, with pharmaceutical products, the counterfeiting of

medicines has implications for public health. In fact, counterfeit

medicines have been identified as one of the most serious public

health problems in China. So, yes, it is much broader than just

films or CDs. It affects a wide range of manufactured products,

particularly in the auto industry.

Representative LEVIN. Thank you, Mr. Chairman.

Chairman LEACH. Thank you.

Mr. Wolf.

Representative WOLF. Thank you, Mr. Chairman. I have a meeting at 12:30, but I just wanted to make a couple of comments for

the record, and ask you a question.

The EU does better. Germany actually has a trade surplus, not

a trade deficit. Frankly, I think part of the responsibility of the

business community has been very complacent. You all have been

so complacent. I think some of you—and I am not addressing you

four, I am talking in general—have been very reluctant to speak

out. It is like you are afraid. You are afraid the Chinese will prevent you from doing business.

I think you have actually been part of the problem, in the sense

that you have not been assertive—now, I sense that is changing.

I appreciate the NAM taking the leadership that it has been taking

lately. But I think that you have been very reluctant to be bold,

to speak out. You have been very reluctant.

For some of you—again, I am not speaking to the four of you—

in the industry, it will be too late. For garlic, it will be too late.

The garlic industry will, for all practical purposes, go. California

will no longer be the big garlic producer.

Apples. The apple industry is precarious. As this moves, applesauce now coming in, now apples. As you cut down those apple

trees, the subdivisions go up. So, for apples, it could be at the end

point.

So, I think the fact that you are beginning to speak out is very

healthy. And I do not want to get into how this is a country that

is a godless, Communist country. I think you have to realize that.

40

I mean, Ronald Reagan’s finest speech was when he called the Soviet Union ‘‘the Evil Empire,’’ because he called it what it was.

I think now the Administration is beginning to kind of catch the

vision. They are concerned politically. I think they now have had

these series of meetings and know how serious a problem it is.

I think you all should push. Why would we not bring a VAT case

with regard to the violation that you mentioned, Mr. Hatano? Why

would you not insist? This is your government. These are people

who are working for you. So, you should insist. The industry in my

area, the Manassas facility which you may or may not be aware of,

has lost a lot of jobs that have gone out. So, you should insist. This

is your government. This is not something that you should be fearful of. They should bring the case.

Just very quickly, I want to ask you this. I read this article in

today’s National Journal. It says, ‘‘Officials from the National Association of Manufacturers and the AFL–CIO’’—that’s an interesting

combination, when you get those two together—‘‘now expect to ask

the White House to begin a so-called section 301 investigation into

whether China is maintaining an unfair trade advantage by keeping its currency artificially strong.’’ Just yes or no. I know where you are now, but do you think that

there should be a case brought? One.

Mr. MARTIN. On the currency issue?

Representative WOLF. Yes.

Mr. MARTIN. I think that the Chinese approach to currency valuation is inappropriate and needs to be changed. Whether or not the

301 case is—— Representative WOLF. By bringing the case, that would not be a

protectionist act, would it? It would seem, based on what Senator

Levin said, it would not be. The law requires, as you get into a

case, that we have a law and we can work within that law. So

would you think that would be a violation or a protectionist act for

us to bring a case with the NAM?

Mr. MARTIN. Section 301?

Representative WOLF. Yes.

Mr. MARTIN. I am not an expert in trade law.

Representative WOLF. No. But, I mean, from your own—— Mr. MARTIN. I think that it sounds logical. I think that our

standard for all of the actions that we contemplate against China

is what will be the most expeditious.

Representative WOLF. And if this were solved, this would help

you tremendously.

Mr. MARTIN. If it does it in a timely fashion and something else

would not be a better alternative.

Representative WOLF. Mr. Smith, do you think this should be a

case? Be bold, now. Just tell us honestly. If you do not think so,

say so.

Mr. SMITH. We do not actually produce stuff in the United

States.

Representative WOLF. No, but you insure people who do, though.

Mr. SMITH. Our companies actually set up operations in China

and then repatriate the profits.

Representative WOLF. So you are neutral then. All right.

Mr. SMITH. Yes.

41

Representative WOLF. Mr. Hatano.

Mr. HATANO. We have not taken a position on the currency issue.

We want to make sure that whatever currency exchange rates

there are are the right ones, and we support and applaud the efforts of the Administration, and NAM, and others who are taking

the lead on that. But we have not taken a position on what the

right mechanism ought to be to get there, or what the right level

is.

Representative WOLF. But the Chinese have no reason to give

unless they are forced to give. I mean, that is business.

Mr. HATANO. Yes, I certainly understand that.

Representative WOLF. They are very tough people. I mean, the

long march that Mao took. This is not a day care facility manager.

These are very tough people.

I do not want to abuse my time. I think you should take a position. If it is no, it is no. If it is yes, then yes.

Mr. HATANO. If I can touch on your question on the VAT.

Representative WOLF. If the Chairman will allow.

Chairman LEACH. Go ahead.

Mr. HATANO. The semiconductor industry has been very aggressive with trade actions in the past. In the Japan case, I think it

is fair to say that we were the first ones to really use 301, when

we were at that time being advised not to really file a case because

it was something one threatens to use rather than uses.

Representative WOLF. Advised by whom?

Mr. HATANO. The U.S. Government. This is back in the 1980s,

with Japan. I am just saying that we have been very aggressive

when we have needed to be. With regard to the VAT, I think we

have tried to take a very reasonable approach and talk with the

Chinese, make sure they are fully aware of what the problem is,

and make sure that they are actually trying to deal with it.

But we will cross the bridge when we get there in terms of filing

a case. I am just emphasizing that we have not been shy in the

past.

Representative WOLF. Well, some of those jobs will no longer be

here, though, if you take too long to cross the bridge.

Mr. HATANO. I understand.

Representative WOLF. I think you have to deal with that.

And I want to commend the NAM. I think you all have really

been providing the leadership. I think, this is your government. I

mean, Ambassador Zoellick is a good man. I think he is a constituent, lives in my district. Good man. He works for you. You pay

his salary. We all work for you. We are public servants. We are

supposed to give you the best judgment.

But I think it is appropriate for you to push your government to

be responsive. I think, for a long period of time, it has not been.

Now I believe that it is. And now that it is, I think this is not the

time to let up. This is the time for you to be aggressive and to

push, because I think this is something that can be done.

I think, quite frankly, there is probably a representative of the

Chinese Government here writing down everything. This government will fall. This government will fall. And when it falls, it will

be chaotic, so there will be an opportunity for the people of China

to live in freedom, for Catholic bishops to give Holy Communion,

42

for Tibet to be free. It will fall. It will fall and it will crumble and

they will pull the people out of the palaces and wherever they are

in Beijing and they will be held accountable. So I think the more

you are pushing, the sooner we can bring freedom, democracy, and

opportunity and openness.

But the way to do that is the way that Ronald Reagan did it, by

being bold, by standing for our values, by articulating, and not

being mean, not being aggressive, not being rough, not being rude,

but bold. So, I think it is time for the industry—and I think you

are now beginning to do that—to be bold. When you are bold, this

government will collapse. There will be freedom. There will be opportunities. But it will not come as fast if you do not push.

I appreciate you being here, and I thank the Chairman for the

extra time, and yield back. Thanks.

Chairman LEACH. Well, thank you very much. I thank this panel.

I would indicate, Frank, that there are expected votes on the House

floor in the near future.

Representative WOLF. I am going to a meeting on the House side.

Chairman LEACH. All right.

Do you have any further questions, Sandy?

Representative LEVIN. No, thank you.

Chairman LEACH. Then we will move to the next panel, which

is the distinguished panel of academics. It is composed of Lawrence

J. Lau, who is the Kwoh-Ting Li professor of economic development

at Stanford University; Margaret M. Pearson, who is professor of

government and politics at the University of Maryland; and

Yasheng Huang, who is associate professor at the Sloan School of

Management at the Massachusetts Institute of Technology.

We welcome the panel. Again, unless there is a prior arrangement, we will proceed in the order in which the introductions were

made.

Professor Lau.

STATEMENT OF LAWRENCE J. LAU, KWOH-TING LI PROFESSOR OF ECONOMIC DEVELOPMENT, STANFORD UNIVERSITY, STANFORD, CA

Mr. LAU. Thank you, Mr. Chairman, distinguished commissioners, ladies and gentlemen. It is a great honor for me to have

the opportunity to testify before your commission. I have some

written testimony. May I request that it be submitted for the

record?

Chairman LEACH. Let me be very precise. All statements will be

fully presented in the record, if there is no objection. You may proceed as you see fit. If it is at all possible, we would like summaries.

I know that is very difficult from the academic arena. We do

have an awkward situation of intervening votes. So, please proceed,

Professor.

Mr. LAU. Thank you very much. I will try to be very brief.

First of all, I would like to say I really endorse the discussion

about the intellectual property rights issue. I believe that if it actually can be pushed successfully, that it would really greatly increase the exports that we might be able to send to China.

But I want to mostly focus on the currency situation and on the

trade balance. I think one of the things that I would like to point

43

out is the following: Although China has a very large surplus with

our country it actually has a deficit with the rest of the world. So,

the aggregate total of the Chinese surplus with respect to the world

is actually not very large. The estimate this year, 2003 is expected

to be around $10 billion worldwide.

Now, when one contrasts this with the Japanese experience, Japan has a large surplus with us, about $80 billion in 2002, or

$60 billion, depending on whose numbers you use. But Japan actually has a very large surplus with the whole world. It is about $80

billion.

So, if there is any disagreement, it is really very much on the

Japanese side, because the Chinese side on current accounts, is actually pretty close to balance. Now, of course, this does not detract

from the fact that we have a large deficit with China.

The second point I would like to make is that if you really look

at the Chinese exports to us, the value added component is actually

very low. It is about 20 percent. That means, for every dollar that

they ship to us, the contribution in China is only around 20 cents.

Now, why is that the case? That is the case because Chinese exports consist mostly of what we call processing and assembly activities, which means that they take what other people have built,

they make goods out of other people’s components and then they

ship the goods to us. So what they are doing is really final finishing

and assembly.

There are two implications. One is that the value added, the gain

that they get from these large exports to us, is actually not that

large because a lot of it actually goes back to Japan, South Korea,

Taiwan, and ASEAN countries.

With all of them, China actually is running a huge deficit because they are taking their parts and components and they are just

putting them together, but they all come here to be sold and the

total counts as Chinese exports. So, I think we need to take that

into account.

But the true implication of that is the following: The currency

movement would not be very useful. I actually support very much

Congresswoman Kaptur’s opinion that the problem is not the exchange rate.

But here, the way to think about it is if the import content is

80 percent, if you appreciate the value of the currency, what it does

is it makes the imported material cheaper, although it makes your

part more expensive.

So, I have done the calculations and, basically, a 10 percent revaluation would only increase Chinese export prices here by 2 percent. It would take a draconian increase in the exchange rate to

make any dent at all.

Now, to convince ourselves that the exchange rate does not really

matter, all we have to do is to look at the Japanese example. From

1960 to now, we have actually managed to push the yuan up from

360 yuan per dollar to, I think yesterday it was about 112, a huge

appreciation. Has it made any difference? No. I mean, basically the

trade deficit continues and it is just about as large as before.

I think, fundamentally, what we need to do is to change the

mind-set, change the Chinese mind-set, that they ought to start importing from us. We should look at the results. The results ought

44

to be that these countries should have overall balance with the

whole world and, therefore, would not take unfair advantage.

Now, if in fact Japan could have balance with the whole world, that means they would have to import $80 billion more and the

United States would actually be a beneficiary if, in fact, imports

could be stepped up.

So let me take 1 minute to make one final point. I really endorse

the Chairman’s position, as well as others, that the exchange rate

ought to be market determined. But in the Chinese case, we need

to do it very carefully because we know that there still exist capital

controls. That means that there are a lot of buyers for dollars in

China who are not allowed to buy. Chinese citizens cannot freely

buy U.S. dollars.

Now, if, in fact, we open it up, I think the currency rate might

well come down rather than go up, if capital controls were removed. It is not just on my authority, but Dr. Nick Lardy, who is

a very distinguished economist working here at the Institute for

International Economics, as well as Dr. Stephen Roach, who is also

well-known, both told me that they would expect the Chinese currency to go down if capital controls were removed.

Now, if capital controls were not removed, we really do not have

a free market because lots of people are being excluded. So, I think

that is really something that we need to think through.

I think we are right to push the Chinese Government to a more

market-based mechanism, but I think we ought to take a look at

the sequencing, how that can be done in a way that is actually beneficial to us, as well as beneficial to the Chinese.

Thank you very much, Mr. Chairman.

[The prepared statement of Mr. Lau appears in the appendix.]

Chairman LEACH. Well, I want to thank you for one of the most

interesting 4 minutes of macroeconomics I have heard this year.

That is extraordinary.

Ms. Pearson.

STATEMENT OF MARGARET M. PEARSON, PROFESSOR OF

GOVERNMENT AND POLITICS, UNIVERSITY OF MARYLAND,

COLLEGE PARK, MD

Ms. PEARSON. Thank you for inviting me to speak in this discussion. I have submitted written testimony that talks about two topics.

One is the evolution in year two of China’s WTO implementation

toward rule of law commitments. I am not going to speak about

that in my oral testimony.

But I will speak about the second topic that I am writing about,

and that is a somewhat different perspective than we have heard

in this forum previously, but it does relate to rule of law issues.

This is to ask the question, ‘‘Is China, now that it is a member

of an international organization, and responsible for ongoing and

future regulation of trade and foreign investment, playing by the

rules of that international body in Geneva at the international

level? ’’ Now that we are nearly 2 years into the process, it is useful

to evaluate China’s behavior in this regard.

Prior to engaging in any assessment of this, though, I think it

is very important to highlight a distinction about the use of the

terms ‘‘cooperation’’ and ‘‘playing by the rules.’’ It is very important

45

that we not conflate the notion of cooperative behavior with adherence to the U.S. Government agenda in WTO.

While, of course, we may strongly prefer that China’s agenda in

the Doha Round is aligned with the preferences of the U.S. Government, playing by the rules in this body really must be measured

in terms of whether a country abides by the norms and rules of the

organization as a whole.

Cooperation cannot be defined by the absence of conflict with

other nations, since conflicts over trade interests are assumed and

built into the process. Indeed, as Mr. Freeman said this morning,

the whole reason, or a big part of the reason, why we wanted

China to join the WTO, is so we had a place to take disputes, just

as we have a place to take disputes with some of our best trading

partners and political allies.

My bottom line answer as to whether China is playing by the

rules in this forum at the international level, is that it has, by and

large, played by the norms and rules of the organization. The Chinese have made no strong effort to change the conservative consensus rules, and it accepts the informal norms of consultation in

the organization. I do expand on this in my written testimony, and

will refer you there.

Chairman LEACH. If I could interrupt for a moment.

Sandy, there are two votes pending. They are both important

votes in the House. They are of a substantial nature relating to

homeland security. What I suggest, Sandy, is that we recess and

return.

Representative LEVIN. All right.

Chairman LEACH. So that the panel in the room understands, it

will probably be a full 15 to 20 minutes. I apologize to each of you

for that, but we are obligated to vote where we can.

Representative LEVIN. We made it by 6 seconds last time.

Chairman LEACH. Right. Thank you.

[Whereupon, at 11:56 a.m. the hearing was recessed.]

[The hearing was reconvened at 1:21 p.m., Chairman Jim Leach

presiding.]

Chairman LEACH. Well, I apologize for the recess, but the Commission will reconvene.

Ms. Pearson, you were in the middle of your testimony. Please

proceed.

Ms. PEARSON. Thank you.

I had just finished saying that my bottom line answer to this

question of whether China plays by the rules in the WTO at the

international level, meaning in Geneva and in other international

forums, is basically that it has.

Mr. Freeman, this morning raised the issue of the TRM, the

transitional review mechanism. Indeed, it was very prickly last

year. That is an area where China has skated close to breaching

some of the norms of what is expected, although I agree with Mr.

Freeman that things look much better for this year.

The second area where China’s behavior is more questionable, is

on the issue of Taiwan. This is not a surprise, certainly, to anybody

who studies China’s role in international organizations. I think

there is not much that is going to change there, but this is considered par for the course and is generally tolerated.

46

I wanted to speak just for a moment about China’s role in the

Group of 22 at Cancun in the Doha Round negotiations 2 weeks

ago, though, because it has received quite a lot of attention.

I believe that, if we were to listen to the headlines which tell us

that China is leading, along with India and Brazil, the Group of

22 to tear apart the negotiations at the WTO, this would be somewhat misleading, and I want to provide some analysis of that.

I confess that China’s participation in this Group of 22 took me

somewhat by surprise in light of China’s earlier expressions of its

interest in agriculture, and when, particularly on tariffs, they expressed quite a lot of commonality with the proposal put forward

by Ambassador Zoellick and Secretary Veneman last year.

However, when you dig deeper into the issue, several points become clear. Let me, just for the sake of time, list them briefly.

China did, of course, lend quite a bit of weight to the G–22 initiative and gave voice once again to its commitment to building a

bridge with the developing world. But if you look carefully, China

was not an active leader of this action. Brazil and India were much

more important, particularly Brazil.

Commerce Minister Lu Fuyuan’s comments in Cancun were designed to be quite conciliatory, in great contrast to the

confrontational statements by the other ministers there. Indeed, it

was quite clear that China did not wish to see the talks break

down or to alienate any other party.

Moreover, statements in the Chinese press about the meetings

and about China’s participation in this coalition of developing countries have been mostly absent. Stories on the meeting have been

very descriptive and simply expressed hope in moving talks ahead.

There is no attempt to gain domestic leverage, to say that, China

is standing up tough to the United States and to the WTO and to

the developed countries. That is absolutely absent in the Chinese

coverage of it.

So, I will just leave you with the thought that, as has been my

impression earlier about China’s basic willingness to play by the

rules of that international organization, the events in Cancun really do not breach that basic conclusion. Thank you.

[The prepared statement of Ms. Pearson appears in the appendix.]

Chairman LEACH. Thank you very much, Ms. Pearson.

Mr. Huang.

STATEMENT OF YASHENG HUANG, ASSOCIATE PROFESSOR,

SLOAN SCHOOL OF MANAGEMENT, MASSACHUSETTS INSTITUTE OF TECHNOLOGY, CAMBRIDGE, MA

Mr. HUANG. Thank you, Mr. Chairman, for giving me this opportunity to testify about a very important issue in Sino-U.S.

relations, as well as an important issue in China’s political and economic transition to a market-based economy.

I sat through the previous two panels. It is an extremely educational experience for me. To some extent, it reminds me of the

many conversations I had with Chinese managers and Chinese officials, and they were equally, if not more, mortified by the prospect

of competing with companies from the United States, companies

from Europe, companies from Japan after China agreed to the

WTO terms.

47

They were extremely worried about the fact that the state sector

is doing horribly. They are laying off workers on the magnitude of

30 to 40 million since 1996. They attribute a lot of that to the fact

that the Chinese market is saturated with foreign-brand products.

They looked at the products that they produced in the 1980s, and

many of these products disappeared. In their place were a lot of

foreign products.

So, it is very interesting to hear their sentiment about this issue

and compare that with the sentiment being expressed here. I think

the truth is probably somewhere in between, and there must be a

constructive solution to these very difficult problems.

Let me just raise three points to summarize my written statement. The first point, is that China acceded to the WTO agreement

in 2000–2001, at a time when its economy was actually very open

to trade and to foreign investment.

By any conventional measures, China’s economy is actually quite

open. The trade/gross domestic product [GDP] ratio is about 40 percent, in comparison with 20 percent for the United States and 20

percent for Japan. Foreign direct investment [FDI], as a percentage

share of domestic investments in the 1990s was 16 to 17 percent.

Now it is coming down quite a bit in the last two years. That

compares with about 6 percent for the United States. So, this is a

country that has no formal investment barriers, and yet the FDI

plays a much smaller role in this economy as compared with what

we normally would call a Communist-controlled economy.

If you look at other measures, you see this sweeping presence of

foreign firms in the Chinese economy. More than 50 percent of Chinese exports are actually produced by companies that are either affiliates or 100 percent subsidiaries of foreign firms, and some of

them are American firms.

Of these foreign affiliates, foreign ownership share of the equity

of these firms is extremely high. Foreign dominance in the Chinese

industries cuts across the board in many industries rather than

just in a few sectors of the economy.

So, here we are talking about an economy that, by these measures,

actually is quite open to foreign trade and to foreign investment.

The second point that I want to make is that this kind of openness is actually quite unusual, for two reasons. One is that compared to domestic trade in China, foreign trade is increasing.

Domestic trade, as a percentage of GDP, is actually decreasing.

Second, there are a lot of barriers. There are barriers toward foreign firms investing in China, but there are also a lot of barriers

established basically to reduce the investment potential of the Chinese companies. These Chinese companies specifically are domestic

private firms. In fact, I would argue that an average domestic private company in China has a tougher time navigating the Chinese

bureaucracy and navigating the Chinese legal system than a typical American company in China.

The third point I want to make is this high FDI inflow into

China, and a high trade/GDP ratio, are in part driven by the inefficiencies of the Chinese financial and legal systems.

They are not a sign of an open policy toward foreign firms, trading with and investing in China. They are a product of the fact that

48

the Chinese Government treats domestic private firms in a worse

manner than it does the foreign firms.

But in the last 3 years as China began to implement some of the

WTO provisions, and at the same time the Chinese Government

began to step up the implementation of internal reforms, the role

of foreign direct investment was decreasing in China.

In the mid-1990s, it was about 6 percent of GDP. Today, it is

about 4 percent of GDP. So I would argue that, as China begins

to reform its economy at a structural level, in fact, you will see

more Chinese competition from China than you do now.

Finally, I would just echo the argument made by Professor Lau.

I do not think it is a currency issue. It is far more complicated and

more difficult. There are far more complicated and more difficult

reasons than the simple issue of currency. Thank you.

[The prepared statement of Mr. Huang appears in the appendix.]

Chairman LEACH. Well, thank you very much, Mr. Huang.

Mr. Levin.

Representative LEVIN. Thank you for your patience. We are really sorry that you had to wait, and also very sorry that everybody

was not here to hear your testimony.

I hope that there will be much more exchange between the three

of you and all of us, because each of you brings a perspective that

we need to hear and we need to have some discussion about them.

Professor Lau, I think that your view of this needs to be very

much in the mix of our discussion and we need to find ways to

have some exchange between you and other economists who disagree with you, because this is not a simple issue.

For example, as you minimize the currency impact of the currency picture on page 4, you talk about the yen depreciating from

360 in the early 1960s to its current 115. If you would, or maybe

we can obtain this otherwise, I wonder what it was in 1995.

Mr. LAU. It was probably around 240, would be my guess. I think

somewhere between 240 and 250, would be my guess.

Representative LEVIN. But also I think you would have to look

at, in terms of the impact of currency valuations, the impact in specific sectors. The fact that it has a deficit with other countries does

not exactly answer the impact on the United States.

There is not time, I think, to talk about this now. But what I

would like to do is to send to you a series of questions, all right?

Because we need to hear this. What you said is somewhat counter

to what may be the new conventional wisdom on the Hill.

Then we were also glad to hear the testimony from Professor

Pearson. Let me just say a word about the TRM. We are kind of

by ourselves here. But I wanted to comment on your comment

about how it is received in China.

I think what you have said, Mr. Leach, means that we have to

try to communicate to the Chinese Government, why the annual

review? Some of us on this panel are in part responsible for it because it was placed in our legislation. It is unique to China, but

that was because of the unique circumstances of China’s accession,

both in terms, as you point out, of the lack of compliance in advance, but I think even more importantly was the size of the Chinese economy, its complexity, and its likely impact in the world.

49

To have simply followed the norms, review every 4 years, was,

we thought, going to be counterproductive and in fact might escalate the tensions instead of reducing them. We thought when we

put our proposals together that organizing and systematizing a review would perhaps lead to some consternation, but in the end lead

to less conflict so we would not resolve these issues by simply filing

cases with the WTO.

So if this is enormously unpopular in China and it is a focal

point for concerns about national humiliation, then we have to do

a better job talking directly to people about why it is there. The

last thing we are trying to do is humiliate. I think it is critical that

that annual review work.

Ms. PEARSON. I would agree that it is absolutely critical for it to

be constructive. There is no point to it if it is not constructive. I

am hopeful, given what Mr. Freeman said this morning, that from

both sides it can become more constructive than simply an exercise

in frustration. So, I appreciate your comments very much.

Representative LEVIN. All right. Well, my time is up. I hope the

three of you will be in considerable contact with us.

Thank you, Mr. Chairman.

Chairman LEACH. Thank you, Mr. Levin.

I would like to turn a little bit to Professor Lau’s observations

and ask for a filling out of some circumstances.

When you note that China, as constituted, is doing a fair amount

of assembling/process kind of work, are you talking about a circumstance that is more in the past and less in the future, or a circumstance that seems to be the established norm?

By that, I mean it would appear to me that China is developing

on a rather rapid basis an infrastructure across the board in many

fields of economic activity. This implies a greater prospect of internal Chinese development of a manufacturing base that is not as dependent upon imports as might have been the case in the past.

Now, is that a fair observation, or how would you define your predictions of China for the future?

Mr. LAU. Mr. Chairman, I think your observation is correct, but

I think it is going to be a long process. The Chinese per capita GDP

today is a little bit less than $1,000 per year, which is a very low

level. Even though growing very fast, it is still a country of great

shortages. For example, each worker has very little capital to work

with. The capital/labor ratio is very low and the vast number of

people are basically unskilled.

So I see that this assembly and processing work would be ongoing for a long time. That does not mean that China would not try

to move up the chain, but by and large moving up the chain does

not really provide enough employment. So, I think the assembly

and processing work would actually be ongoing for quite a while.

If you look at what happened to Taiwan, China is now doing everything that Taiwan was doing 25 years ago, assembling things.

Then Taiwan has moved up. Someone just told me, on personal

computers and hand-held devices today, that the design work is

actually being done in Taiwan. It used to be done in Silicon Valley

in California, and now it has all moved to Taiwan. So, Taiwan has

sort of moved up the chain and just given the assembly work across

the strait.

50

I think that is pretty much what really is happening. Korea is

doing the same thing. Japan. So the Chinese are getting all the

assembly work, but it does not pay very much. The value added

proportion is very low.

Chairman LEACH. Let me ask all of you, in a general macroeconomic sense, observers of the world economy that includes Asia,

that is not exclusive to Asia, have noted that capacity to produce

almost everything is in excess today.

If you take the human component, if you take the Asia side of

the Pacific Rim, there are approximately 3 billion people, of which

two-thirds are work age. If you take America, we have 110, 120

million in the workforce.

There are very few things that increasingly, with modern communications, apply not only to all of the electronics, but with more

sophisticated shipping of cargo, and for that matter more sophisticated rail shipping in the United States, that it is going to be harder and harder to keep manufacturing here in America given these

trends.

So one of the great questions is how you bring equity to trade.

Then it is compounded by this notion that modern communications

imply productivity improvements that are rather substantial. So,

last year, the stunning statistic in America that we had a 5 percent

productivity increase and a decrease in employment, that is a fairly

stunning thought.

In a way, it applies to us, but it also could apply to China. That

is, a 10 percent GDP pick-up may not mean a 10 percent employment pick-up. When one thinks of massive unemployment in China

or underemployment in China, that is a worrisome thing for their

society from their perspective, and also one that, from our perspective, makes us wonder how we keep our workforce intact.

Do any of you have recommendations on the right level of American judgment that should be applied to our situation and the right

level of judgment that ought to be applied to theirs? How do we

parse these demographic situations in such a way that all our societies benefit? Is that a conceivable thing to do?

Mr. Huang, do you have any thoughts?

Mr. HUANG. Let me get to this question maybe from a slightly

different perspective. I want to emphasize that there are similarities between China and the rest of East Asia in terms of their increasing export capacity.

But there is a critical difference. That difference benefits the

United States far more than the growth of Japan and other East

Asian economies in the 1960s and 1970s. That is the role of foreign

direct investment. Mr. Chairman, you are exactly right that technology is moving in such a way, the communication costs are coming down, air transport, shipping, all these things are becoming

extremely cheap.

So, to the extent that some of these manufacturing operations

are going to migrate out of the United States, then this country is

faced with two choices. One is do you want to lay a claim on the

assets abroad, such as in China or do you want to face the competition from the Chinese companies owned and operated by the Chinese themselves?

51

Now, foreign direct investment is enabling the United States to

lay a claim on this incredible growth of industries in China.

Motorola alone, in the 1990s, just one company, accounted for 50

percent of Chinese electronics exports to the United States. The

shareholders of Motorola benefit from this. The affiliates of Motorola benefit from this, because many of these products come back to

the United States to feed into the next chain of production, whereas, the United States was not able to do that vis-a-vis Japan, visa-vis Korea.

So, China’s growth is not achieved at the expense of America at

large. I recognize that there are manufacturing industries in the

United States, that labor is suffering. But there are a lot of other

people who benefit from this. The Wal-Mart example is a very good

one. I shop at Wal-Mart, and as far as I can see there are a lot

of Americans shopping at Wal-Mart.

They benefit tremendously from the production of goods in China

in two ways, financially, because American citizens have a financial claim over these assets in China, and second, they benefit

because they can buy these goods at very cheap prices.

Chairman LEACH. Dr. Lau.

Mr. LAU. Mr. Chairman, if I just might add, very briefly. One interesting thing is that the United States and China are actually

complementary in terms of their industrial mix. China does not export anything that we export. We do not export anything that

China exports. So, it is actually a good fit.

Representative LEVIN. How about steel?

Mr. LAU. I mean, China is now importing a lot of steel.

Representative LEVIN. They exported it in 1997.

Mr. LAU. That is right. There might be some exceptions, but by

and large the economies are very complementary. We are good at

high-tech, they are good at assembly.

I think that is why there is actually a much better basis for these

two economies to work together than, for example, between the

United States and Japan, where there is actually much more competition. So I think one should be able to fashion a win-win strategy.

Now, I accept that there are transition pains on both sides, because there will be job displacement on both sides. For example,

General Motors establishing a shop in Shanghai is going to drive

out some local Chinese automobile firms. Many of them have to go.

So it is really the adjustment costs that we need to think

through, as to how we take care of the displaced workers, both in

this country and in China.

I think that there should be enough gravy generated that we can

actually fashion something that could work. I actually try to promote an idea. We know that textile factories in the Carolinas are

doing terribly. I actually floated the idea that perhaps some large

textile company in China should come and take a look, see if they

could take over some of them, take over the workers, use the brand

names, continue the brand names and sort of keep the companies

going.

I think there are really ways of making this work so that it

would actually be mutually beneficial. It does not have to be a

trade war. It is much better to increase exports of both countries

than to reduce exports of both countries to the other. Thank you.

52

Chairman LEACH. Ms. Pearson, do you want to add anything? Is

there hope?

Ms. PEARSON. Well, I think that it is a difficult situation. It is

fundamentally difficult. But what troubles me about so much of the

debate that I hear now, particularly about the insertion of this currency manipulation argument, is that if you are concerned about

the loss of American manufacturing jobs to pressure China to float

its currency, it does not solve the problem.

The loss of American jobs or China’s taking over of manufacturing is, as many have said but it does not seem to be heard in

this debate, taking over jobs that have come to it from the rest of

East and Southeast Asia. So, it is troubling to hear the argument

that if China floats its currency it is going to save American manufacturing. I think that kind of broad-brush approach to the problem

is difficult.

Again, I have not heard it too much from this body, but when

I read the media and when I hear much of what is going on in the

political discussion and the discussion among pundits in Washington now, that assumption frequently seems to be made.

Chairman LEACH. Let me just say, I do not think there is anyone

that thinks that simply changing the currency saves the jobs. I do

think that there is an equity issue that is not trivial. It comes back

to economics.

Several of you are economists, whether you believe in fixed exchange rates or flexible exchange rates, and whether or not there

are models of manipulation based on fixed rates that benefit some

parts of a society and disadvantage other parts. That implies both

within the two societies that are involved in this circumstance, or

the multitude of societies that are involved. I think the case for

moving the direction of flexible exchange rates is good for all

parties.

I also think that it is a more stable system and that experiments

with trying to keep things fixed, which implies stability, is actually

a very unstable situation. I think that is mainstream American

modern economic thinking. I do not think that is aberrational

thinking.

Although there are cases in which you have economists who have

argued that sometimes there is a case for a country to have a fixed

exchange rate using the United States as a currency base. We experimented with that with Argentina; not only did it not do well

in Argentina, it set a real cloud over America’s economic relations

with the rest of Latin America.

So I am not arguing for any precise number, but I do argue very

strenuously for flexible exchange rate regimes as being helpful to

all modern societies. I think you also have, from China’s perspective, a circumstance where, if you have flexible exchange rates, it

is like the WTO.

You enter into a fair trade regime and you protect your ability,

if you have the ability, to do things better than someone else. If you

do not have that ability, you are unprotected. So I think it is something that one should not be apologetic about arguing for. I think

it is very much in the interest of world society.

Even though Sandy’s brother notes that it is not a very compelling argument in countries like Japan or China about protecting

53

the public, I think it is a protection to public treasuries not to have

fixed exchange rate regimes that get artificially propped up because the sum total of trade can overwhelm those public efforts, so

it is a reasonable thing to assert and affirm.

Ms. PEARSON. In terms of where the economic system eventually

will get in China, I think that is very reasonable. Indeed, it seems

to me that Chinese banking officials and very high-level officials

have argued for many years that the goal is to eventually float the

currency. The real debate is over whether it should be done tomorrow, or by 2005, or 2010. That is probably where the disagreement

comes on it from both the Chinese side and this side.

Chairman LEACH. Both the Chinese and what side?

Ms. PEARSON. That is where it comes from both sides, the Chinese side and the U.S. side.

Chairman LEACH. I want to be careful. I think that is where the

debate comes from, the Chinese side. I do not think it is the position of the U.S. Government to assert 2010. I think that a general

frame of reference is one for competition in exchange rates. So I do

not think it is a both-sided thing.

Ms. PEARSON. I understand the U.S. Government is not giving a

date of 2010. I am saying that the dispute is probably over the pace

at which we get there.

Mr. HUANG. Also, I think it is sequencing. It is timing as well

as sequencing. The real flow of the currency, at a time when Chinese financial institutions are struggling with 50 percent bad loans

on their balance sheet, the state-owned sector is in a huge mess,

do you liberalize the capital controls at this particular juncture?

So the timing is actually conditional upon the sequence of reforms that the government has to undertake. I do not think it is

in the interest of the United States to engineer something that may

lead to a higher probability of a financial crisis in China.

So pegging the currency actually serves two purposes. One, is to

keep the Chinese currency cheap in order to increase China’s competitiveness. But this is a function that is being performed now.

In 1997, the pegging of the Chinese currency served to prevent

a massive depreciation of Chinese currency that would have destabilized Asia in a very dramatic fashion as Thailand, South Korea,

and other Asian countries went into a financial crisis.

So I think there is a need to be cautious about when to do this

and what kind of unanticipated effects can be associated with such

a dramatic change in the currency pegging system.

Representative LEVIN. Let me just say, I guess we are winding

up. I think we understand there are complexities, but they sometimes tie us into knots. I do not think that that is where we should

be.

The same, if I might say so, is to Professor Lau’s argument about

transition. First of all, I think in some sectors China is moving to

value added production and more rapidly than some thought. It is

not that they are simply assembling things that come from elsewhere.

That was true some years ago, but I think it is increasingly

changing. There is more talent there than we give credit for, more

engineers there than we sometimes understand.

54

Second, I think people in this country are asking—and it is a legitimate question—transition to what? The fact that there is no answer here in terms of job loss, I think, illustrates the question of

‘‘transition to what’’ is an important issue that we need to consider.

We do not have time, but the textile and apparel industry is a

good example. There is a fear not only in the United States, but

in the Caribbean generally that China, once the quotas are lifted,

will capture 75, 80 percent of the market, and not simply by assembling materials that come from elsewhere. So it may be a small

part of the GDP of the United States, but it would be a pretty large

part of the GDP of Caribbean nations.

But we will have another hearing, right?

Chairman LEACH. I want to have just one more question. The

three of you are experts from where you reside on the subject of

academics. I raise this because, having just been to the Far East,

I am really struck by the sensitivity of the issue of visas and how

we go about issuing them, and what could occur come next January

when new rules go into effect.

I am a big believer that education is an export item, as well as

a cultural circumstance. The United States has begun the process

of restricting our own exports, which is a bizarre situation.

Now, we all recognize the new order in the world and the new

challenges to the world, and we all recognize the difficulty in making exceptions in some parts of the world to the rules on visas.

But I am worried sick that the United States is going to (a) lose

an export market, and (b) cause real kinds of dissent in parts of

the world that we do not like to see dissent increase.

Now, from your perspectives at MIT, the University of Maryland,

Stanford, are you sensing this sort of thing developing, or have I

exaggerated that prospect?

Professor Lau.

Mr. LAU. This is a problem. We noticed that a lot of students are

contacting us about not having enough time. We actually sometimes have to call or write our consulates, hoping to move and expedite the process.

But I think I would say, with sufficient notice, we can probably

do it. I mean, we just have to move the dates up a little bit.

But I think what we could also do to make it easier is perhaps

to somehow raise the visa fees and hire more people, because it increases through-put. There is really no reason why someone who

is coming to either Stanford, MIT, Berkeley, whichever, they have

honest-to-God admissions and they are good students, why we

should not try to process them as quickly as we can, subject to our

rules.

I think having more people would make it possible, because right

now the big bottleneck is scheduling the interviews, I understand.

Everybody has to be interviewed.

Chairman LEACH. In addition, they are going to be required to

be fingerprinted, or other kind of biological identifier.

Mr. LAU. I think that is all right. I mean, I do not think people

would object to fingerprinting, or retina scanning, or whatever. I

think that actually is a process that I think every country is moving to, because I think that basically eliminates counterfeiters. So

55

I think people can understand that. But I think it delays the timing.

Chairman LEACH. That matters the most.

Mr. LAU. Yes.

Chairman LEACH. Where the good students at Stanford and

Berkeley, and the great students at the University of Iowa. Is that

what you are saying?

Mr. LAU. Right. Exactly.

Chairman LEACH. Ms. Pearson.

Ms. PEARSON. My concerns are actually very similar to yours. We

do lose very good students who do a lot for us when they are here,

and in important ways serve as ambassadors or modes of communication between the United States and China when they return

home. I am concerned about it.

Chairman LEACH. Thank you.

Dr. Huang.

Mr. HUANG. I think this is an extremely important issue. There

was a story in the New York Times about a Chinese doctor who

was unable to come to a medical conference in the United States.

The reason I bring up this story, is that the date of the publication of that story is very significant. It appeared on September 10,

2001. The next day, out of 19 hijackers of these planes, I think half

of them did not really need a visa to come to the United States.

So these kinds of restrictions are being placed on the Chinese,

extremely talented people who come to study, who then may decide

to stay as I have, but we are continuing to make contributions to

both the United States and to China. Many of these people are not

allowed to come. The educational programs are not just benefiting

from this kind of exchange financially.

The United States gains a tremendous amount of benefit in

terms of the values, in terms of knowledge that we impart to the

younger generation of Chinese. I would urge the U.S. Government

to keep that in mind when it designs its policies on this issue.

Thank you.

56

Chairman LEACH. Well, thank you all very much. Thank you. Let

me bring this hearing to an end and say we are particularly appreciative of the academic witnesses, particularly the two of you that

have come from far distances. Ms. Pearson, we consider you a home

town source of great value.

Thank you all very much.

[Whereupon, at 2:05 p.m. the hearing was concluded.]

(57)

A P P E N D I X

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PREPARED STATEMENTS

PREPARED STATEMENT OF HENRY A. LEVINE

SEPTEMBER 24, 2003

Mr. Chairman and members of the Commission, thank you very much for inviting

me to participate in this hearing.

The Department of Commerce is dedicated to making sure ‘‘China is playing by

the rules’’ and we continue active efforts, in coordination with U.S. companies and

other U.S. agencies, to that end. I recently returned from China with Assistant Secretary William Lash. We worked on preparations for Secretary Evans’s October trip

to China and met with senior officials to discuss China’s WTO compliance record

and other bilateral trade issues. We stressed the need for China to implement its

WTO commitments fully and on time.

The stakes involved in seeing that China ‘‘plays by the rules’’ are large. China

is our fourth largest trading partner. Bilateral merchandise trade reached $147.2

billion in 2002. Our imports from China have been growing rapidly. China overtook

Japan to become our third largest source of imports last year, and surpassed Mexico

in July to become our second largest source of imports. Because our imports from

China are more than five times greater than our exports, China has become our

largest deficit-trading partner. The bilateral trade deficit, which hit $103 billion in

2002, reached $65 billion in the first 7 months of this year.

While our deficit with China has continued to soar, it is also worth noting that

since 2001, China has been by far our fastest growing export market among our top

10 trading partners. Although our exports to the world declined 7 percent in 2001,

5 percent last year, and rose less than 3 percent in the first 7 months of this year,

our exports to China surged 19 percent in 2001, 15 percent last year and more than

22 percent in January–July. Along with the United States, China now accounts for

most of the current growth in the world economy.

As you know, the Administration has placed much emphasis on responding to the

concerns of the U.S. manufacturing sector. In March 2003, Secretary Evans directed

the Commerce Department to lead a comprehensive review of the issues influencing

long-term competitiveness of U.S. manufacturing, and to outline a strategy for ensuring that government is doing all it can to create the conditions for manufacturers

to thrive. This review will culminate in a report to be released later this fall. In

developing this report, Commerce Department officials held roundtable discussions

in more than 20 cities across the country—from Manchester, NH to Columbus, OH

to Detroit to Los Angeles—meeting with manufacturers in the aerospace sector,

autos, semiconductors, pharmaceuticals, among others.

In response to the concerns we have heard, Secretary Evans has already announced several new initiatives, including the creation of an Assistant Secretary focused on the needs or manufactures supported by a new Office of Industry Analysis

to focus on the needs of American manufacturers, the creation of a new Assistant

Secretary for Trade Promotion to boost our exports, and the establishment of an Unfair Trade Practices Team to track, detect and confront unfair competition.

During the roundtable discussions, no country raised more attention as a source

of concern than China. Our manufacturers complained about rampant piracy of intellectual property; forced transfer of technology from firms launching joint ventures

in China; trade barriers; and capital markets that are largely insulated from freemarket pressures. We have also heard rising concerns about the pace and direction

of China’s implementation of its WTO commitments in areas such as transparency,

IPR protection, trading rights and distribution services, agriculture, and financial

services.

Americans are willing to compete, on even terms, with any country in the world

but we will not stand for unfair competition. We will not look the other way or wait

idly. As the Secretary stated in a recent speech to the Detroit Economic Club,

‘‘American manufacturers can compete against any country’s white collars and blue

collars, but we will not submit to competing against another country’s choke collars.’’

To ensure that China honors its commitments and that U.S. companies benefit

from these opportunities, we have adopted an aggressive and multi-pronged approach. We are going to target unfair trade practices wherever they occur. We are

exploring the use of new tools to expand our trade promotion activities related to

China. We are expanding our efforts to engage Chinese officials to help make sure

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they ‘‘get the rules right’’ as they continue their massive task of restructuring their

economic system.

In the area of intellectual property rights (IPR) protection, despite China’s com- mitments to cracking down on rampant piracy, fake CDs, DVDs and pharmaceuticals continue to flood the market, costing us estimated $20–25 billion annually.

In fact, the Business Software Alliance estimates that software piracy rates in

China exceed 90 percent. In response, we continue to insist that the Chinese government take the steps necessary to bring these problems under control. We have

raised specific IPR concerns at our meetings with senior Chinese government officials. Through the annual Special 301 process, working with our colleagues in other

agencies, we continue to closely monitor China’s IPR conditions. To make sure that

China has the tools to implement its commitments we have organized a series of

seminars with Chinese officials conveying U.S. views on how best to increase criminal enforcement of IPR violators and stop cross-border trade in pirated products. We

think China can and should do better in these areas. We will continue to press for

this goal.

In our manufacturing roundtables many companies have expressed concern over

the exchange rate of the Chinese Yuan. This administration believes that currency

values should be set by free-market forces. Secretary Snow delivered exactly that

message to the Chinese government 3 weeks ago.

While continuing our focus on China’s WTO implementation and other trade practices, we will continue to enhance the ability of U.S. businesses, especially small and

medium-sized businesses, to compete in China. We are launching ‘‘Doing Business

in China’’ seminars in cities across the country, which address small business concerns pertaining to the Chinese market. We are enhancing our efforts to insure that

U.S.-developed technical standards are accepted in China just as they are accepted

elsewhere internationally. We are exploring ways to develop more trade leads in

China and to provide even more targeted information on China opportunities for

companies in the United States.

Combined with these domestic efforts, we regularly engage Chinese government

officials to ensure trade agreement compliance and market access for our products

and services. Secretary Evans will visit China in October to advance U.S. interests

and ensure U.S. companies face a level playing field in our economic relations with

China. We will have another opportunity to raise outstanding issues during the 15th

U.S.-China Joint Commission on Commerce and Trade (JCCT). Secretary Evans has

issued an invitation to host China’s Minister of Commerce Lu in Washington for the

JCCT by the end of this year. We are still awaiting an official response.

Thank you for devoting this hearing to these important issues, and I welcome

your questions.

PREPARED STATEMENT OF CHARLES W. FREEMAN III

SEPTEMBER 24, 2003

Thank you for inviting me to appear before you today to discuss the Administration’s perspectives on the United States’ trade relationship with the People’s Republic

of China and, in particular, the topic of China’s WTO implementation.

CHINA’S IMPLEMENTATION OF ITS WTO COMMITMENTS

China acceded to the WTO on December 11, 2001, after 15 years of negotiation

with the United States and other members of the WTO and its antecedent, the General Agreement on Tariffs and Trade. China’s accession was a watershed event for

both China and the United States. By committing to implement the WTO’s market

access, national treatment and transparency standards; protect intellectual property

rights; and limit the use of trade-distorting domestic subsidies, China promised to

deepen and consolidate the market-oriented economic reforms first initiated in the

years following the death of Mao Zedong. For the United States, China’s WTO accession not only promised unprecedented market access to one of the world’s most intriguing, and fastest growing, economies; it also provided a forum through which the

United States and China could mediate and resolve trade disputes without the use

of unilateral measures. At its heart, China’s WTO accession represents a commitment by China to play by the established rules of international trade both at the

border and internally, and thus was a fundamental step toward establishing the primacy of the rule of law in China.

China has now been a WTO member for more than 21 months. In that time China

has completed much of the nuts-and-bolts work of WTO implementation: amending

and promulgating thousands of laws and regulations to effect its WTO commitVerDate 11-MAY-2000 10:53 Dec 19, 2003 Jkt 000000 PO 00000 Frm 00063 Fmt 6601 Sfmt 6621 90833.TXT China1 PsN: China1
60

ments, establishing new transparency procedures in many national and sub-national

agencies, and reducing tariffs to their committed levels. This work has taken place

against a challenging political and social backdrop: since December 2001 China

underwent a major leadership change; passed through a harrowing national SARS

epidemic; faced unprecedented protests by some 600,000 Hong Kong citizens; and

generally has confronted the host of dislocations inherent in its transition from a

planned to a more market-oriented economy.

Whether or not China’s domestic difficulties have had an impact on its ability to

implement its WTO commitments in both letter and spirit, the Administration has

noted a variety of shortcomings in WTO implementation over the course of the past

21 months. As highlighted in our 2002 Report to Congress on China’s WTO Compliance, covering China’s first year of WTO membership, China’s WTO implementation

was most problematic in the areas of agriculture, services, enforcement of intellectual property rights and transparency. Although we have seen progress in some of

these areas, they still remain areas of serious concern. At the same time, other

areas of concern have begun to emerge. For example, China’s use of certain tax policies to favor domestic production or provide incentives to increase exports has developed into a significant source of concern. In some sectors that the Administration

has engaged with China and resolved WTO trade-related concerns, new problems

have emerged in place of those resolved through engagement.

In our experience, China’s compliance problems are occasionally generated by a

lack of coordination among relevant ministries in the Chinese government. Another

source of compliance problems has been a lack of effective or uniform application

of China’s WTO commitments at local and provincial levels. China is taking steps

to address both of these concerns, through more effective inter-ministerial mechanisms at the national level, and through a more concerted effort to reinforce the importance of WTO-consistency with sub-national authorities. In other cases, however,

compliance problems involve entrenched domestic Chinese interests that may be

seeking to minimize their exposure to foreign competition. These problems are difficult to deal with, and even after the Administration has engaged with China and

resolved our concerns, new problems have often emerged in place of those resolved

through engagement.

The central lesson the Administration has learned with respect to China’s WTO

implementation is that the years of tough negotiations that led up to China’s WTO

accession were no accident. We will need to match the painstaking efforts and persistence of those negotiators in order to ensure that China implements its commitments fully. While providing an exhaustive inventory of bilateral trade concerns is

beyond the scope of this statement, I would propose to highlight a number of central

concerns and the ongoing efforts of the Administration in pursuing their resolution.

AGRICULTURE

China’s potential as a market for U.S. exports of bulk agricultural commodities

was a key factor in U.S. support for China’s WTO accession and grant of Permanent

Normal Trade Relations (PNTR) status to China. While bumper harvests of some

crops in China in 2002 may have limited the commercial potential of some U.S. exports, China’s attempts to restrict certain agricultural imports has been an ongoing

theme of the first 21 months since China’s WTO accession. The use of—or even the

threat to use—questionable GMO standards and sanitary and phytosanitary (SPS)

measures to restrict imports of some products for alleged health and safety concerns

has frustrated efforts of U.S. agriculture traders, most notably in the case of soybeans. In the case of those bulk agricultural commodities subject to negotiated tariff-rate quotas (TRQs) in China, the setting of sub-quotas, use of Catch–22 import

licensing procedures, allocation of TRQs in commercially unviable quantities and a

lack of transparency in TRQ allocation and management have combined to disturb

what should be a ready market for U.S. exporters, particularly in the case of cotton.

After the efforts of Ambassador Zoellick, Agriculture Secretary Veneman and others in the Administration, the commercial impact of these potential barriers was

contained. U.S. exports of soybeans topped $1.2 billion—a record—and cotton sales

were already 8–10 times greater than in any previous calendar year by July, 2003.

Nevertheless, systemic problems with both GMO and SPS regulation continue to

hang like a cloud over the marketplace, and a negotiated settlement to our concerns

with China’s TRQ system has yet to be fully implemented. These and other emerging concerns, such as China’s apparent use of supports to promote agricultural exports, will require continued vigilance and engagement by the Administration in

order to prevent a disruption in this important trade.

61

INTELLECTUAL PROPERTY RIGHTS

In the year leading up to WTO accession, China did make significant improvements to its framework of laws and regulations protecting intellectual property

rights (IPR). However, the lack of effective IPR enforcement in China is a major obstacle toward a meaningful system of IPR protection. IPR problems run the gamut,

from rampant piracy of film and other entertainment products, to sophisticated software and semiconductor products, to counterfeiting of consumer goods, electrical

equipment, automotive parts and pharmaceuticals. IPR infringements not only have

an economic toll; but also present a direct challenge to China’s ability to regulate

those products that have health and safety implications for China’s population and

international purchasers of such products. While a domestic Chinese business constituency is increasingly active in promoting IPR protection for self-interested reasons, the problem is immensely widespread. If significant improvements are to be

achieved on this front, China will have to devote considerable resources and political

will to this problem, and there will continue to be a need for sustained efforts from

the United States and other WTO members.

The United States has had an ongoing dialog with China on IPR matters for a

number of years, including through an annual series of bilateral meetings chaired

by USTR and its Chinese counterpart, the Ministry of Commerce, the next series

of which is scheduled for November this year. Ambassador Zoellick, Secretary

Evans, and, most recently, Secretary of Treasury Snow have used every occasion to

press China on the importance of a more effective regime for IPR enforcement. In

the view of the Administration, the key to achieving this end will be for China to

increase deterrent-level criminal penalties for IPR violators, demonstrate a willingness to increase prosecution and punishment of IPR offenders, to lower thresholds

for criminal prosecution, to increase resources and devote more training for enforcement

in all parts of China, and to establish more effective communication procedures

between relevant officials of China’s courts and investigative units, the Supreme

People’s Procuratorate and China’s lawmaking bodies.

SERVICES

Meanwhile, concerns arose in many services sectors, principally due to transparency problems and China’s use of prudential requirements that exceed international norms. The United States and China have had reasonably cooperative talks

to resolve these concerns in many of the affected sectors, but progress has been slow

and not without frustrations. In some cases, such as express courier services, much

progress was made toward resolving regulatory concerns in 2002, but problematic

regulations remain under consideration, even if they have yet to be implemented.

In other cases, such as implementation of China’s commitments on branching by insurance companies, the United States and China remain at odds despite a longstanding cordial and otherwise productive dialog with Chinese regulators.

VALUE-ADDED TAX POLICIES

China has increasingly used value-added tax (VAT) policies to encourage domestic

industrial or agricultural production in a number of sectors. In the case of semiconductors, China’s policy of providing rebates of VAT to domestic semiconductor

producers disadvantages U.S. exports and raises significant WTO compliance concerns. In the case of fertilizer, China exempts from the VAT fertilizers that compete

directly with the principal U.S. fertilizer export, a practice that is difficult to justify

by WTO rules. In addition, we also have received reports that China has been rebating the VAT paid on domestically produced agricultural goods, including corn, and

even that China is rebating the VAT in such a way as to subsidize exports—a

particularly serious charge, given China’s WTO commitment to eliminate export

subsidies. The Administration has engaged China on all these practices, and will

continue to pursue the elimination of discriminatory or trade-distorting VAT policies

through appropriate channels in Beijing, Washington and Geneva.

CHINA’S WTO TRANSITIONAL REVIEW MECHANISM

China was admitted to the WTO on somewhat unique terms. Rather than completing the process of implementing its WTO commitments as a pre-condition of

WTO membership, China was admitted to the WTO by committing to implement

them. In large part to monitor China’s transition toward full implementation, the

WTO conducts an annual review of China’s implementation progress: the Transitional Review Mechanism (TRM). This review, which will take place in 8 of the next

9 years in 16 subsidiary bodies as a lead-up to the year-end meeting of the WTO’s

General Council, is an opportunity for other WTO members to engage China on the

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extent to which it has complied with its commitments and to clarify China’s trade

practices. The first year of the TRM was marked by some misunderstanding between China and other WTO members as to expectations of China at the TRM, but

communication clearly improved as the process unfolded. The Administration expects a smoother and more useful TRM in year two and beyond.

IMPORTS

The trade imbalance between the United States and China topped $103 billion in

2002, and threatens to climb higher in 2003. I should point out that this is in part

a result of the expansion of our overall trade relationship: While imports from China

out pace those from all other WTO members, China is also our fastest growing export market. In 2002 our exports to China were over $22 billion, and, with exports

through July 2003 up 22.7 percent compared with the equivalent period in 2002,

China has become our 6th largest export market. Nevertheless, the rapid expansion

of trade between our two countries has inevitably lead in some cases to competition

between domestically produced goods and imports in both our markets. To the extent China unfairly protects its domestic producers to the detriment of competition

from United States, the Administration continues to be prepared to assert U.S. interests. To the extent imports from China disrupt U.S. markets, the Administration

is fully prepared to assert the rights of the United States under China’s WTO accession agreement.

As part of China’s WTO accession package, China agreed to two separate Chinaspecific safeguard mechanisms to allow WTO members to cope with market disruptions caused by increasing economic integration with China, particularly during the

period when China is still phasing in its WTO commitments. One such mechanism,

the product-specific safeguard, was codified as Section 421 of the Trade Act of 1974,

as amended, and is available until December 11, 2013. Since the implementation

of Section 421, three petitions have been brought requesting import relief. In one

case, the International Trade Commission found that our domestic producers’ market had not been disrupted by imports from China. In two other cases, while the

ITC found market disruption, the President determined that the adverse impact on

the U.S. economy was clearly greater than the benefits from providing import relief.

While to date no import relief has been granted under Section 421, the President,

in his most recent determination, reiterated his commitment to using the safeguard

when the circumstances of a particular case warrant.

The second safeguard agreed to by China as part of its WTO accession package

is specific to textiles, and allows WTO members the opportunity to invoke limited

import relief—specifically a 7.5 percent cap on growth in imports of a given textile

category for up to 1 year (6 percent for wool products)—until December 31, 2008.

The Administration is currently reviewing three requests under this safeguard

mechanism, and initial determinations will be forthcoming in mid-November of this

year.

U.S.-CHINA DIALOGUE ON ECONOMIC MATTERS

The Administration maintains three formal dialogs with Chinese ministries. The

Commerce Department chairs meetings of the Joint Commission on Commerce and

Trade; the Treasury conducts meetings of the Joint Economic Commission with the

Chinese Ministry of Finance; and USTR chairs an interagency Trade Dialogue with

counterparts from the Ministry of Commerce and relevant other Chinese agencies.

Like many of the informal contacts, these formal occasions are opportunities not

merely to discuss bilateral and multilateral trade and economic matters, but are

themselves action-forcing events at which significant progress can be achieved. They

also act as an early warning system on trade problems—providing an opportunity

to resolve issues before they become broader bilateral irritants.

In addition to these formal processes, the Administration meets frequently on

both the Cabinet and sub-cabinet level with senior Chinese officials, and uses such

meetings to press the importance of economic issues with Chinese counterparts. In

the case of USTR, Ambassador Zoellick meets or speaks via telephone with PRC

Minister of Commerce Lu Fuyuan on a regular basis, has been to China twice since

December 11, 2001, and plans to travel to China again for bilateral discussions next

month. Ambassador Josette Sheeran Shiner recently confirmed as Deputy USTR,

plans to continue an active dialog with her counterparts, and other USTR officials

meet regularly with Chinese officials on bilateral trade concerns, whether in Washington, Beijing, or at the WTO. These exchanges are critical opportunities to

advance bilateral and multilateral trade and economic matters, and have proven

effective in making progress on key U.S. concerns.

63

CONCLUSION

Mr. Chairman and members of the Commission, thank you for providing me with

the opportunity to testify. I look forward to your questions.

PREPARED STATEMENT OF GARY C. MARTIN

SEPTEMBER 24, 2003

Thank you for the honor and opportunity to address the Congressional-Executive

Commission on China.

The North American Export Grain Association (NAEGA), established in 1912, is

comprised of private and publicly owned companies and farmer-owned cooperatives

involved in and providing services to the bulk grain and oilseed exporting industry.

NAEGA member companies ship practically all of the bulk grains and oilseeds exported each year from the United States. The Association’s mission is to promote

and sustain the development of commercial export of grain and oilseed trade from

the United States. NAEGA acts to accomplish this mission from its office in Washington DC, and in markets throughout the world. NAEGA has a joint operating and

service agreement with the National Grain and Feed Association (NGFA), whose

1,000 member companies consist of all sectors of the U.S. grain, feed processing and

exporting business. NGFA member companies operate approximately 5,000 facilities

that handle more than two-thirds of all U.S. grains and oilseeds. NGFA and

NAEGA coordinate policy and government representation on trade related issues

that affect economic prospects of the industry. This enables the organizations to

speak in a unified voice to government and to the industry’s domestic and international customers.

Our trade relationship with the People’s Republic of China is of great importance

to the economic success of U.S. agriculture. Compliance with the World Trade Organization (WTO) rules is a foundation of successful economies around the world as

well as critical element in a successful trade relationship with China. The North

American Export Grain Association has a long history of facilitating the export of

U.S. wheat, corn and soybeans to China. We are very much engaged in resolution

of concerns related to several questions to be addressed in today’s hearing. In particular, I would like to focus on three questions: Which Chinese government policies

have made Chinese exports competitive? Which remaining non-tariff barriers hinder

market access for U.S. imports into China? and, what type of U.S. Government policy changes could help in changing conditions in China?

By most measures, China’s efforts to meet it’s WTO commitments to reduce both

tariff and non-tariff barriers in the agricultural sector have been met with mixed

results. There has been welcome progress in some key areas such as tariff reductions. Unfortunately, many issues that amount to non-tariff barriers continue to

limit progress under China’s WTO commitments and exports to the Chinese marketplace. However, from the perspective of U.S. agriculture and the grain trade, the

impact of China trade is difficult to overstate. Likewise the implementation of China’s WTO commitments continues to have a profound impact.

To put some perspective on the questions under consideration by the Committee,

we should acknowledge the recent growth in agricultural exports to China. On a

July through June basis, we have seen total value of U.S. agricultural exports to

China rise from less than $500 million in 1999 to almost $2.25 billion in 2003. Since

China was accepted into the WTO (December 2002), it is safe to say that U.S. agriculture exports to China are on a pace to double in value.

When China imports the impact can be quite dramatic. Our soybean sales to

China this year may exceed $2 billion. U.S. soybean exports to China represent not

only a very large percentage of overall U.S. soybean exports but also big piece of

our overall agricultural export value and very large, market dominating share of

world trade in soybeans.

When China stops imports or fails to meet expectations, the result is a large negative impact on our agricultural markets. A short 20–30 day interruption in soybean

trading (due to uncertainty over biotechnology policy) last year may have resulted

in up to $100 million in lost U.S. sales. Expectations of large export markets for

U.S. corn and wheat simply have not been met. While import demand for these

crops is largely dependent on domestic supply, we think it is clear that WTO noncompliant policies of the Chinese government have stimulated production, reduced

access and, in the case of corn, subsidized exports. For wheat, calendar year to date

exports total over 1 million tons—up 104 percent from 2002. Chinese wheat imports

have fallen this year by 60 percent to about 200,000 tons. Chinese corn exports have

recently overtaken several long term U.S. corn export markets. This year China has

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exported 50 percent more corn than it did in the same period last year—a calendar

year to date total of over 9 million tons. Our expectations were for Chinese membership in the WTO to result in significant imports from the United States of both corn

and wheat.

As China continues to transition its economy and agricultural policies, we expect

China will continue progress toward a policy more accommodating to international

trade. I believe China recognizes the need to further open agricultural markets to

provide for enhanced food security and economic well being. The difficulty is in the

transition from a centrally planned and managed economy to an economy that benefits from allowing market forces to prevail. For agriculture, as we too have experienced, this transition can be especially difficult.

In response to these three questions: Which Chinese government policies have

made Chinese exports competitive? Which remaining non-tariff barriers hinder market access for U.S. imports into China? and what type of U.S. Government policy

changes could help in changing conditions in China?—There are several key issues

related to trade in agricultural products that need to be addressed:

• Uncertainty regarding biotech regulations and the issuance of permanent safety

certificates for biotech products. Much progress has been made in this regard. Our

industry is especially appreciative of the effective and timely response of President Bush and his Administration in moving this complex and difficult issue very

close to resolution. • Labeling and information requirements on meat and poultry products that increase export costs without enhancing food safety. • Chinese adherence to the Agreement on the Application of Sanitary and

Phytosanitary Measures (the SPS Agreement). Particular concerns regarding the

failure to utilize the International Plant Protection Convention and ‘‘zero toler- ance’’ pathogen standards that are neither science-based or practical, as well as

undue quantitative restrictions on meat and poultry imports. • Administrative interference with import trade by China’s quarantine authorities

and Ministry of Commerce, including requiring import permits before signing

purchase contracts and making shipment. Most administrative measures lack

transparency and appear to be used to institute short term quotas established to

address political concerns.

• Significant export subsidies for agricultural products, particularly corn.

• A range of problems with the implementation of China’s promised tariff-rate

quota (TRQ) system, including a lack of transparency, delay in the announcement

of quotas, granting of insignificant and uneconomic quotas, imposition of restrictions that are not required of domestic producers or merchants, and inclusion of

quotas for mandatory re-export.

While China has eliminated or reduced some tariff barriers, the benefits from

these actions can be quickly offset by continued non-tariff barriers that restrict

trade into China, create significant marketplace uncertainty and discourage further

foreign investment. The agricultural TRQ issue has the potential to be the first case

against China under the WTO dispute resolution system. U.S. industry has consistently called for science-based, permanent rules for genetically modified organism

(GMO) imports, a transparent TRQ system, and an end to agricultural export subsidies.

The progress made by the governments of China and the United States through

collaborative work to reduce these unjustified barriers to agricultural imports has

been significant and is certainly in the best interest of both countries and the modernization of Chinese food production.

We need to aggressively focus the attention and improve China’s compliance with

the WTO in three areas: (1) the regulatory practices of Chinese State Administration

of Quality Supervision and Inspection and Quarantine (AQSIQ); (2) the complete

and final elimination of agricultural export subsidies; and (3) the implementation

of agricultural TRQ systems.

AQSIQ REGULATORY PRACTICES

U.S. soybean, cotton and meat traders continue to experience significant restrictions on exports of products to China stemming from AQSIQ’s posture on the

issuance of Import of Animal and Plant Quarantine permits and its inspection procedures. Chinese quarantine regulations require importers to obtain import permits

before entering into purchase contracts and effecting shipments. With import permits valid for only 90 days or less, buyers are locked into a very narrow period to

purchase, transport and discharge their cargoes before expiration of the permit.

While the technical requirement imposed on importers is to obtain an import permit

in advance of contracting for commodity shipments, the current AQSIQ requirement

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is essentially unworkable, as importers buy products when prices are low—some- times months ahead of actual shipment. Contracting parties cannot wait to obtain

an import permit first, before making a contract for shipment of commodities.

Although China removed soybean import quota control in 1999, the Chinese government now appears to control import volume through WTO-inconsistent methods

such as the use of quarantine import permits.

In the recent past, AQSIQ has slowed the issuance of permits, which has resulted

in significant commercial uncertainty and, in some cases, has placed U.S. foreign

investment in the Chinese agricultural sector at risk. Because of the commercial necessity to contract for commodity shipments when prices are low, combined with the

inherent delays in having import permits issued, many cargoes of soybeans end up

arriving in Chinese ports without import permits. This has created delays in vessel

discharge and resulted in demurrage bills for Chinese buyers.

AQSIQ has committed to notify importers about the result of their permit application within 30 days of receipt. However, some importers are waiting well beyond 30

days without obtaining any feedback from AQSIQ, as provincial CIQ offices that act

as intake centers for import permit applications appear to be asked to delay submitting these applications to AQSIQ in Beijing. This effectively extends the 30-day notice period AQSIQ has to respond to the party requesting an import permit.

Most recently, AQSIQ has suggested to foreign diplomats that it will take action

to restrict specific firms from exporting or importing soybeans based on allegations

that the firms have failed to meet certain quarantine regulation and mandatory

quality requirements. The quality requirements and quarantine regulations are undocumented, non-transparent and do not comply with the requirement of the WTO

SPS Agreement or the International Plant Protection Convention.

Recommendations:

• AQSIQ should restrict its activities to science-based, WTO and international convention compliant import quarantine procedures and should not impose delays,

uncertainties, commercially discriminatory or commercially unrealistic requirements that inhibit free trade.

• AQSIQ should approach the approval of import permit requests in a timely and

commercially realistic manner.

• AQSIQ should ensure that all formalities are transparent, with clear timelines

openly promulgated.

AGRICULTURAL EXPORT SUBSIDIES

U.S. feed grain producers and exporters have serious concerns about China’s failure to live up to the commitment to eliminate export subsidies for corn.

We are convinced China is using export subsidies to ship major volumes of corn

into markets such as South Korea, Malaysia, Indonesia and most recently Japan.

After a record-setting year in 2002, exporting more than 11.6 million tons of corn,

China is currently 100 percent above that year’s pace in exporting 6.7 million metric

tons in the first 6 months of 2003 (1.8 million metric tons in June alone). Those

exports have come mostly at the expense of the U.S. corn industry. If China’s use

of export subsidies for corn is not addressed now, we will continue to see significant

erosion of U.S. markets throughout Asia.

Prior to its WTO entry, China subsidized corn exports at $40–$45 per ton. However, throughout much of 2002 and 2003, the price for Chinese corn exports has

remained at pre-accession levels. Given China’s ocean freight and internal corn

costs, it is inexplicable how corn could be exported at those prices without further

government subsidization, even after accounting for measures outlined by the Chinese government to reduce corn export prices. By calculating the size of the gap between domestic and export prices, the findings refute explanations given by Chinese

officials as to how China was able to reduce corn export prices after WTO accession

by means allowable under WTO rules, i.e., VAT rebate and transportation tax waivers.

Recently, world prices have increased while China’s domestic corn prices have decreased, reducing the need for export subsidies. However, we still question how

China is exporting at levels of $15 to $25 per ton below domestic prices. We are

also concerned that the VAT is not being collected on domestic corn, or is being assessed at a much lower rate than the officially declared 13 percent. Furthermore,

with China’s grain stocks currently at a very high level, there will be additional

pressure for China to continue to aggressively subsidize corn exports throughout

next year if allowed to do so. China has exported more than 18 million metric tons

of corn at price levels significantly below domestic prices during the past year.

Although China has announced measures to lower the corn price for export within

WTO disciplines, it is clear that corn exports continue to be subsidized by the

government.

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1 It should be noted that China’s Ministry of Commerce and National Development and Reform Commission has recently published a draft regulation amending management of TRQs for

imported agricultural products. The impact of the new regulation needs further review.

Although the subsidy gap between China’s domestic and export prices for corn has

narrowed in 2003, it still accounts for a substantial competitive advantage for China

as its exports remain at record high levels. Based on data provided by the U.S.

Grains Council, Chinese exports to South Korea in June were priced at $106 FOB

China (Dalian). Mid-June domestic corn prices at Dalian were 1060 RMB/mt or

$128/mt. On a direct comparison basis, the gap between domestic and export prices

would then stand at $22/mt for June. Using a 6-month lag from the time contracts

were signed and shipments exported—so that the June export price is compared to

December 2002 domestic price (1030 RMB, or $124.50)—the gap amounts to about

$18.50 (about 15 percent of the domestic FOB Dalian price).

While export prices for the July September period may be slightly higher than

June’s $106/mt, they most likely will not be more than $110/mt (current domestic

Dalian prices are unchanged at $128/mt). That implies a significant gap continuing

in the foreseeable future. If China continues to apply these levels of subsidies to

corn exports the remainder of this year, U.S. exports will be significantly impaired

in this current marketing year.

Recommendations:

• China should formally and fully account for the discrepancy in domestic and export corn prices.

• China should immediately meet its WTO commitment and proceed to eliminate

the officially supported mechanisms that permit exports at lower than domestic

prices.

AGRICULTURAL TARIFF RATE QUOTAS

China has not made sufficient progress1 in implementing tariff rate quotas

(TRQs) for bulk agricultural commodities such as wheat, corn, cotton and vegetable

oil in a manner that opens the market to trade as anticipated under China’s WTO

accession agreement. Regulations designed to establish TRQ systems were late in

being released, lack sufficient transparency and introduce unreasonable licensing

procedures for importers. In some cases, China has contravened its accession agreement by allowing TRQs reserved for ‘‘non-state trading companies’’ to be issued to

state-owned enterprises.

The TRQs for corn and wheat in many cases were distributed in such small quantities as to render them uneconomic to fulfill. When TRQs were issued, it has been

very difficult, if not impossible, to ascertain which companies were granted quotas.

This is in violation of the WTO agreement.

Of greatest concern is that the State Development and Reform Commission

(SDRC) requires a significant portion of each TRQ be used only for processing and

mandatory re-export of finished products. This restriction is most important for cotton, where well over one half of the TRQ is restricted to re-exports and represents

a violation of China’s accession agreement.

Recommendations:

• China should honor its TRQ obligations and not engage in such practices as: delaying announcements; granting insignificant, uneconomic quotas; applying restrictions that are not required of domestic producers or merchants; or designing

non-tariff trade barriers that circumvent TRQ obligations.

• China should ensure that there is greater transparency in the TRQ process, including the requirement to publish a list of importers that have been granted

TRQ allocations.

• China should eliminate the quota for mandatory re-export provisions.

In summary, much has been accomplished with regard to Chinese accession to the

WTO and the commitments related to agricultural trade. However Chinese commitments and U.S. expectations are for additional and more timely progress. The

United States and Chinese government have demonstrated an ability to resolve

some outstanding issues. Given the importance of several unresolved concerns to

both China, the U.S. and global markets, renewed commitment and additional effort

by the United States, China, and the WTO are warranted.

Thank You

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PREPARED STATEMENT OF BRAD SMITH

SEPTEMBER 24, 2003

OVERVIEW

Thank you, Mr. Chairman and Commission Members, for the opportunity to testify. If it is acceptable, I would like to have my written testimony, which expands

on my oral comments, added to the record.

The U.S. insurance industry strongly supported permanent normal trade relations

(PNTR) for China because the Chinese accession package was extremely broad and

deep, and when fully implemented holds the promise of opening the vast Chinese

insurance market to U.S. insurance and retirement security providers. We were

aware from the outset that no agreement is self-implementing, and that the key to

realizing successful profit from Chinese accession to the WTO is an efficient and

transparent implementation process.

With the ongoing leadership and support of the U.S. Government trade negotiators and facilitators, ACLI and our property casualty counterparts at the American

Insurance Association have established what we consider to be a positive implementation dialog with the Chinese Insurance Regulatory Commission (CIRC), which has

already led to a much improved communications and transparency process for U.S.

insurers in China.

Based on draft regulations just released by CIRC, we are cautiously optimistic

that our primary concern to date (unjustifiably high capitalization requirements)

has largely been addressed. As the next step, we have submitted a detailed list of

additional questions to which we are seeking clarification from CIRC. We are optimistic that the United States Trade Representative (USTR) will be able to schedule

a meeting to review this agenda by the end of the year.

BACKGROUND

China’s formal membership in the World Trade Organization offers great promise

and opportunity for life insurers. The ACLI and the broader U.S. insurance industry, especially our property casualty counterpart—the American Insurance Association, were strong supporters of Permanent Normal Trade Relations (PNTR) for

China because the insurance liberalization commitments contained in China’s schedule of specific commitments and ‘‘Working Party Report’’ were broad and deep, holding the promise of opening the Chinese market to U.S. insurance companies and

pension providers. Through experience with bilateral insurance agreements in

Japan and South Korea, we knew at the time of China’s accession that no agreement is self-implementing, and that the most important part of the opening of the

Chinese insurance market would be in the implementation phase.

With China now in the WTO, through the good offices of the U.S. Trade Representative, the U.S. Commerce, State and Treasury Departments, and through the

communications of many interested Members of Congress, we (ACLI and AIA) have

begun the process of establishing a dialog with the Chinese Insurance Regulatory

Commission (CIRC) about the implementation of their liberalization commitments.

Establishment of regular, straightforward two-way communication is, in our opinion, the best way to avoid possible misunderstandings, frustrations or disappointment about China’s liberalization process.

The task before CIRC is substantial, as it is in everyone’s interest that the Chinese insurance market not only be open but well run and prudentially sound. Our

intent is therefore to make a positive contribution to this process, by providing

CIRC and other Chinese decision makers our comments on their implementing regulations, and where appropriate, include technical research to help them in setting

standards that meet the test of prudential justification.

Individual company experience with CIRC varies greatly. Some describe relations

as perfect and others describe them as frustrating, but our member companies support this constructive engagement approach for the same reasons many companies

have funded representative offices all over China, some going back for more than

10 years. The Chinese market is seen to have tremendous potential, and many U.S.

companies, like our international competition, see entry into China as key to a global strategy. Recent industry press headlines such as ‘‘Chinese Insurance Premium

Grew 33 percent For First 7 Months’’ and ‘‘China Will Be Second Largest Insurance

Market by 2032, Says IBM,’’ typify stories of the growth of the market since first

being liberalized in 1992—we intend to be part of that.

With regard to China’s implementation of their WTO insurance commitments,

while the process is moving forward, the lack of clarity in the regulatory process

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has slowed and confused the fulfillment of China’s insurance liberalization obligations.

Since joining the WTO in December of 2001, Chinese insurance regulators have

promulgated five sets of regulations with the stated intention of implementing China’s WTO insurance commitments. The first set went into effect in early February

of 2002 and provided a general framework for the regulatory structure but offered

little specificity regarding the implementation of their liberalization commitments.

Procedures for branching, capitalization and solvency regulation and other fundamental processes by which U.S. Insurers could procure a license and begin operations were not included. US insurers provided an analysis of these regulations for

USTR, pointing out the vagaries of the regulation as well as several specific regulatory articles that could be inconsistent with China’s WTO obligations. USTR then

met with Chinese regulators to communicate these questions and concerns and were

told additional regulations would be forthcoming.

Chinese regulators subsequently released a second set of regulations in late February 2002 to further clarify the licensing procedures. USTR again communicated

directly with CIRC regarding questions and concerns, which still had not been clarified. CIRC informed USTR of further forthcoming regulations and stated that China

would fully implement their WTO liberalization commitments.

Concurrent with this informal bilateral dialog, USTR had requested answers to

a detailed set of the same questions at the Transitional Review Mechanism discussion in the WTO Committee of Trade in Financial Services. This engagement has

been continued at each subsequent CTFS meeting, with the same questions being

echoed by the Governments of Canada, the European Union, Australia, South Korea

and Switzerland.

Based on both the formal requests in the CTFS and the informal bilateral dialog,

in October of 2002, Ambassador John Huntsman requested a meeting with CIRC

that would be open to a small number of U.S. and Chinese insurance industry representatives as well as USTR representatives. At the suggestion of USTR, it was

decided to focus exclusively on the highest priority issue—capitalization levels required of an initial establishment of a foreign insurer, and subsequent capitalization

required when additional branches would be opened.

Our concerns were that the regulations were unclear because of conflicting overlap from multiple regulations, and because the amounts called for were well outside

of prudentially justifiable international norms, thus creating a barrier to entry for

many U.S. insurers. Our objective for the meeting was to seek clarification of the

specific requirements, and to provide information on international benchmarks for

prudentially justifiable capitalization levels. Thanks again to USTR, the U.S. Embassy in Beijing and the U.S. Commerce Department, on December 13, 2002 we participated in a meeting in Beijing with CIRC, Chinese industry representatives and

a U.S. Government and industry delegation headed by Deputy Assistant USTR,

Charles Freeman.

Our presentation, attached for entry into the record, was entitled ‘‘A Recommendation for Revisions to the Capitalization Requirement Rules for Life Insurance Companies Operating in China,’’ highlighted just how far outside international

norms China’s capitalization levels were, and presented a model that our consultant, Watson Wyatt Insurance Consulting Limited, felt might be more appropriate

for the Chinese life insurance market. CIRC listened, agreed that our worst-case

projection of the capitalization requirements was currently correct, stated that there

were plans to revise the relevant regulations, and agreed to consider our views.

Meanwhile, we discussed our capitalization concerns with other service industry

groups in the U.S., Canada, Europe and Japan, fellow members of the ‘‘Financial

Leaders Group’’ and found that our capitalization concerns were not unique. Service

sectors such as banking, securities, auto finance and express delivery are facing

similar problems. Thus, in February of 2003, the Financial Leaders Group delivered

a letter to Chinese officials commenting on the prudentially unjustifiably high capitalization levels in many services sectors, including insurance, and the issue was

again highlighted at the CTFS meetings in Geneva by the Quad Governments.

CIRC subsequently stated that additional regulations to fulfill China’s WTO liberalization commitments would be forthcoming.

It should be noted that neither of the first two insurance regulations were publicly

released in draft for public comment. The U.S. industry provided comments anyway:

No formal response was received.

On July 31, 2003 a third set of regulations (‘‘The Draft Trial Implementing Rules

on the Regulations of the PRC on the Administration of Foreign-Invested Insurance

Companies’’) were placed on the CIRC web site with a request for public comment

by August 15. To our surprise, on August 18, 2003, another set of regulations

(‘‘Draft Administrative Regulations on Insurance Companies of the People’s Republic

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of China’’) was also posted to the CIRC web site requesting public comment by September 16. In both instances, we translated the draft regulations and circulated

them widely within the U.S. insurance industry.

In both instances we submitted formal written responses to CIRC within the requested timeframe. We commended them for their public outreach, and stated that

their openness supports our firm belief that the most important factor contributing

toward the successful development of the Chinese insurance sector will be the institutionalization of a regular and robust public dialog. We expressed our hope that

this initiative can be expanded through increased communication and cooperation

with interested international companies and industry associations, and committed

ourselves to provide professional and timely responses to CIRC on an ongoing basis.

We also stated that a dialog on these drafts and/or any revised drafts that CIRC

circulates for additional comment would be an excellent basis for continuing the dialog we began last December in Beijing.

The major notable development in these recent drafts is a significant lowering of

the required capital for initial establishment and full national operations, which, if

implemented, bring the capitalization requirements closer to the acceptable range

of international comparables for some lines of business and business models. This

is a major step forward for CIRC, which we feel supports the benefits of continued

dialog. We plan to extend this dialog to now include our other priority areas of concern.

Continuation of this dialog must be two-way. Many of our concerns involve confirmation of our understanding of the meaning of vague or conflicting regulations.

So that this dialog is as clear as possible, we hope to receive written responses to

our inquiries from CIRC. This has also been requested by USTR. We look forward

to a meeting in Beijing to focus on this agenda by the end of the year, and greatly

appreciate USTR’s efforts to schedule it.

Top priorities we would like to have included in the dialog agenda are (by category of type of issue):

FUNDAMENTAL ASSUMPTIONS

We seek confirmation of the following fundamental assumptions, which are key

to our understanding of the prudential intentions of the Chinese Insurance Regulatory System.

Fundamental Assumption—1

That CIRC is undertaking, through measures to date and in the future, an approach consistent with the PRC’s WTO obligations regarding market access, national treatment and transparency, and that the only discrimination (differences)

between provisions for domestic and foreign insurance companies is where there is

a clear and necessary prudential justification. Furthermore, that it is the goal of

CIRC is to have one set of regulations and procedures for domestic and foreign companies, so that the regulations are consistent with China’s WTO commitments.

Fundamental Assumption—2

That there are three (3) documents/rules/regulations relevant to this exercise. They

are (working back from the present): (A) the Draft Insurance Company Administrative Regulations (hereinafter the ‘‘Measures.’’); (B) the Draft Trial Implementing

Rules on the Regulations of the PRC on the Administration of Foreign-Invested Insurance Companies, July 31, 2003 (hereinafter ‘‘Implementing Rules’’); and (C) The

Administrative Regulations on Foreign-Invested Insurance Companies of the PRC,

Feb. 2002 (hereinafter the ‘‘Administrative Regulations’’).

Fundamental Assumption—3

That the three documents are each intended to accomplish a specific regulatory

function and that there is no intentional overlap or conflict between the provisions

of the three documents, especially with regard to the application of measures as between domestic and foreign companies.

Fundamental Assumption—4

That only the ‘‘Implementing Rules;’’ and the ‘‘Administrative Regulations’’ are

applicable specifically to foreign companies.

Fundamental Assumption—5

That the ‘‘Measures’’ are relevant to all companies both domestic and foreign

equally without discriminatory interpretation.

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IMPLEMENTATION GAPS

We would like written responses to three questions regarding gaps in the regulations where they should reference major elements of the implementation of China’s

WTO liberalization commitments:

Implementation Gap—1

It should be noted in the ‘‘Implementing Rules’’ that several existing joint venture

companies have foreign registered capital interests that are above 50 percent. It

should be confirmed that these companies, and any subsequent foreign companies

approved by CIRC to own more that 50 percent, are grandfathered in accordance

with China’s WTO commitments, and that such companies will be allowed to expand

geographically (through branches and sub-branches) in their current ownership

structure.

Implementation Gap—2

Prior to China’s WTO accession, a number of foreign insurance companies were

allowed to establish operations in the PRC. All of these companies were requested

by the Chinese Government to incorporate as operational branches, not as subsidiaries.

However, in both of the two new sets of draft regulations (the ‘‘Administrative

Regulations,’’ and the ‘‘Implementing Rules’’), there does not appear to be any article that addresses the maintenance and development of these branch operations. We

believe a section should be added explaining the administrative procedures under

which a ‘‘guaranteed branch/sub-branch structure’’ should be allowed to operate. (By

‘‘guaranteed branch/sub-branch structure’’ we mean branches and sub-branches

whose solvency is guaranteed and supported by the total assets of the parent company.) The branch/sub-branch structure is a well-established international norm appropriate for application in China. Accordingly, regulations should be developed to

govern those branches already established in China and such future branches that

may be established in China. We recommend that these regulations conform to the

internationally accepted branch/sub-branch operating structure.

Indeed, in most countries and in accordance with international norms, when insurance companies enter foreign markets, they are allowed to establish an initial

branch or home office and then expand to new locations throughout the country

through a network of sub-branches. These sub-branches report to the original

branch or home office.

This branch/sub-branch structure is supported by, and legally tied back to, its

corporate parent. Thus, branch operations should not be treated as if they were

separate, stand-alone entities. Likewise, because a branch/sub-branch structure is

supported by its parent corporation’s assets, the company should not have to recapitalize when expanding to a new location. This branch/sub-branch operating

structure is an established international norm and a widely accepted principle of

operation.

For property casualty insurance companies the ability to expand by sub-branch

is particularly important. Foreign insurance companies should be allowed to expand

geographically in the Chinese insurance market in accordance with established

international norms and operating practices (i.e., through the use of the internationally accepted branch/sub-branch structure). Specifically, foreign insurance companies should be able to establish a branch (with a reasonable initial capitalization)

backed up by the strength of the parent organization, and be allowed to expand

throughout the country—in accordance with China’s timetable for the phase-out of

geographical restrictions—through the establishment of sub-branches. The establishment of sub-branches should not be limited to the immediate, licensed region or

territory. Also, the company should not have to separately capitalize each new location.

We also request clarification with respect to branch boundaries. We believe that

it is more efficient to establish provincial-level branches rather than only municipallevel branches. Domestic companies are able to operate at the provincial level with

access to all cities and localities in the province. To date foreign companies have

received approval to operate at only in one specific city. Foreign companies like their

domestic counterparts should have provincial level licenses.

The proposed rules are also silent as to their impact on existing insurance company operations, including existing branches. It is, therefore, assumed that branches

and other insurance company operations that exist today may, but are not required

to, continue to operate under the conditions and approvals that existed prior to this

rule, including but not limited to operations, financial structure, capital and mode

of establishment. This understanding should be confirmed.

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Implementation Gap—3

In addition to its insurance and reinsurance liberalization commitments, China

committed to liberalize its pension market within 5 years of joining the WTO. To

date, no regulations or laws have been released in anticipation of the opening of this

important market sector. CIRC or other relevant authorities, should begin a public

comment process well in advance of the approaching phase in deadline to gain the

broadest level of comment and support for this fundamental undertaking.

NATIONAL TREATMENT QUESTIONS

In addition to the questions on fundamental assumptions and the further information needed to fill the implementation gaps, we would also like to receive confirmations from CIRC on the following specific questions regarding national treatment.

National Treatment Question—1

RE: Article 3 on the August 18th Draft of Administrative Regulations on Insurance Companies of the People’s Republic of China. If we understand this correctly

we interpret it to say that with respect to branch boundaries for foreign invested

insurance companies, that they are treated the same as domestic companies which

we understand are defined at the provincial-level (On May 21, CIRC approved Min

Sheng Life to prepare 4 branches in Beijing, Nanjing, Hangzhou, and Shijiazhuang.

(Source: China Insurance News, June 2003) If this is a correct understanding we

believe that it is more efficient, and is a major step forward for CIRC in fulfilling

their mission to implement China’s WTO national treatment obligations. Domestic

companies are able to operate at the provincial level with access to all cities and

localities in the province. To date foreign companies have received approval to operate at only in one specific city. Foreign companies like their domestic counterparts

should have provincial level licenses.

National Treatment Question—2

RE: Article 11 on the August 18th Draft of Administrative Regulations on Insurance Companies of the People’s Republic of China. If we understand this correctly,

we interpret it to say that with respect to branch applications for foreign invested

insurance companies, that they are treated the same as domestic companies which

we understand can apply for any number of branch approvals simultaneously with

no limit to the number of branches a company may be granted at any given time.

National Treatment Question—3

RE: Article 13 of the August 18th Draft of Administrative Regulations on Insurance Companies of the People’s Republic of China. As there is no reference to any

waiting period, we request confirmation in this article that no waiting period exists

before licensed insurance companies, domestic or foreign, can apply for branch or

sub-branch licenses.

National Treatment Question—4

RE: Article 99 of the August 18th Draft of Administrative Regulations on Insurance Companies of the People’s Republic of China. As it is so vague, we are concerned that Article 99 could be used to justify discrimination against foreign insurers,

contrary to China’s WTO commitments on national treatment. Accordingly, we

would urge confirmation that the scope of Article 99 is limited solely to matters

where the prudential justification will be clearly explained and limited to as least

discriminatory as possible.

PRUDENTIAL JUSTIFICATIONS

In addition to the questions on fundamental assumptions, the further information

needed to fill the implementation gaps, and questions of national treatment we

would also like to receive responses from CIRC on the following questions of prudential justification.

Prudential Justification—1

RE: Article 6 (b) of the August 18th Draft of Administrative Regulations on Insurance Companies of the People’s Republic of China. We would like to understand the

prudential reasoning behind the capitalization requirements. We believe that

RMB200 million is too prescriptive in nature and may be much higher than international norms with respect to specific business models and risks being assumed.

We feel that CIRC should be granted the discretion to lower this amount where it

feels appropriate. Also, we request clarification of the scope of the initial establishment of RMB 200 million. Please confirm that this includes the right to establish

sub-branches without limitation as to numbers.

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Prudential Justification—2

RE: Article 12 of the August 18th Draft of Administrative Regulations on Insurance Companies of the People’s Republic of China. We would like to understand the

prudential reasoning behind the branching capitalization requirements of RMB20

million for each additional branch. We feel this is duplicative, contrary to China’s

WTO commitments, and has no prudential justification. Additionally we feel it is an

inefficient use of capital, which will raise the cost of products to Chinese consumers.

In summary, it is vitally important that all parties work together in a clear and

open manner to ensure understanding of CIRC’s implementation process. Any measures China implements that give the impression of falling short of its WTO commitments and denying U.S. insurance companies meaningful market access in China

could create hostility. Thus, it is in the interests of CIRC to continue a meaningful

two-way dialog to make the implementation of China’s WTO insurance commitments as smooth and positive as possible.

ACLI and our industry colleagues appreciate the hard work and high-level leadership of USTR and the other relevant U.S. Government agencies that have helped

establish and grow this dialog with China. Likewise, the industry greatly appreciates the ongoing support of Members of Congress. We consider ourselves still at

the beginning of a complex process, and will look forward to an ongoing relationship

with your Commission as we proceed through the years to come. While we do not

know when China’s draft regulations will enter into force, it is our hope that our

dialog, with your and the government’s assistance, will produce a transparent and

effective body of regulations comporting with China’s strong and admirable WTO

commitments. We will report to you as circumstances develop.

Thank you for your interest and consideration in this matter. I would be pleased

to answer any questions that you may have.

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1The four regions are North America (primarily the United States), Europe, Japan, and Asia

Pacific.

PREPARED STATEMENT OF DARYL HATANO

SEPTEMBER 24, 2003

Chairman Leach, Chairman Hagel, distinguished Commission members, the Semiconductor Industry Association (SIA) is pleased to testify today regarding China’s

compliance with its WTO commitments. The SIA represents the $70 billion U.S.

semiconductor industry. U.S. semiconductor firms are leading global competitors,

commanding 50 percent of world market share.

China represents a large and growing market for semiconductors and other information technology products. In fact, semiconductors are the second largest U.S.

export to China. Over the past decade, SIA was a strong supporter of legislation to

provide Permanent Normal Trade Relations with China as part of China’s entry into

the WTO, and SIA is pleased that the Chinese government has taken a number of

positive steps in implementing its WTO obligations. However, several areas will require continued efforts by the Chinese government in order to fulfill the commitments made under WTO accession. My comments today will only elaborate on those

issues of special relevance to American semiconductor producers, including China’s

value added tax rebates for domestically produced chips, semiconductor intellectual

property, transparency, and local content.

CHINA MARKET

In 2001 the Asia Pacific region, driven primarily by growth in China, surpassed

the U.S. as the largest semiconductor market in the world. In terms of demand, in

1997, the U.S. represented 33 percent of the world market, while the Asia Pacific

region represented 22 percent. Five years later, in 2002, the Asia Pacific share had

grown to 36 percent, compared to the U.S. share of 22 percent—a reversal of positions. By 2005, the U.S. is projected to be the smallest of the four regional markets,1

representing only 18 percent of the world, less than half of the 40 percent share

that the Asia Pacific market is projected to represent. The growth of the Asia Pacific

market has been driven by the growth in China. China’s $18 billion integrated circuit market represented 15 percent of total world demand in 2002, up from 7 percent of the world in 2000.

China’s semiconductor market growth is occurring within the context of significant growth in China’s computer and telecommunications markets. China is now the

world’s largest mobile phone market, and second largest personal computer market.

Currently domestic Chinese production, including foreign owned facilities in

China, meets only about 15 to 20 percent of its market demand, with the remaining

80 to 85 percent met by imports. The Chinese government’s Tenth Five Year Plan,

covering 2001–2005, has an ambitious target to ensure that by 2005 ‘‘60 percent of

IT products should be home grown,’’ and that China shall ‘‘gradually design and

develop its own IC products, (including [central processing units]).’’

SIA’S EFFORTS IN CHINA

SIA has been encouraging an open trade environment in China for over a decade.

SIA has sent delegations to China since the early 1990s to meet directly with Chinese government and industry officials to discuss the benefits of market liberalization to China’s economic growth and to U.S.-China relations. SIA provided advice

to the U.S. Government on the WTO accession issues of importance to the semiconductor industry and, as noted earlier, was an active supporter of legislation to allow

Permanent Normal Trade Relations with China.

Based on SIA’s interactions with senior Chinese government officials, we believe

that there is a genuine commitment expressed by all Chinese officials to full and

faithful execution of China’s WTO obligations.

SIA was pleased that China became a signatory of the WTO’s Information Technology Agreement (ITA) in April 2003, committing to eliminate tariffs on a range

of information technology products. SIA has long supported the elimination of semiconductor tariffs, beginning with the suspension of U.S. tariffs in 1985, because tariffs increase costs to consumers and thus impede the ability of consumers to take

advantage of semiconductor technology. SIA was an early supporter of the ITA, and

China’s joining this agreement was a high priority because of the consumer benefits

that would flow from the elimination of tariffs on semiconductors, computers, telecommunications equipment, and semiconductor manufacturing equipment. The

elimination of China’s 6 to 12 percent semiconductor tariffs in January 2002, conVerDate 11-MAY-2000 10:53 Dec 19, 2003 Jkt 000000 PO 00000 Frm 00142 Fmt 6601 Sfmt 6621 90833.TXT China1 PsN: China1
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2State Council Document Number 18, June 2000.

tributed to a reduction in smuggling and resulting shift to legitimate import channels, better positioning U.S. companies to take advantage of trading rights when

they are fully phased in at the end of 2004 (3 years after accession). SIA was

pleased that China was able to resolve the ‘‘end use’’ certification issue that had initially prevented its formal participation in the ITA. China had imposed ‘‘end use’’

certification requirements on 15 ITA products, that were inconsistent with the ITA,

and would have created a dangerous precedent, especially as we sought to expand

the ITA to additional countries. SIA is pleased that China is now a full participant

in the ITA, and we appreciate the efforts of USTR that led to this result.

VALUE-ADDED TAX

China imposes a value-added tax (VAT) of 17 percent on sales of all imported and

domestically produced semiconductors and integrated circuits. However, current

Chinese government policy provides for a rebate of the amount of the VAT burden

in excess of 6 percent for integrated circuits manufactured within China (and the

amount of the VAT burden in excess of 3 percent for integrated circuit designs developed in China).2 This discrimination against imported semiconductors through

the VAT rebate is inconsistent with China’s WTO obligations.

Reduction of the semiconductor VAT should apply to all semiconductors and integrated circuits sold in China (whether domestically produced or imported). Application

of the VAT reduction to all companies would allow China to come into compliance

with its WTO obligations to refrain from discrimination against imports while maintaining its commitments to investors in domestic facilities of a reduced VAT rate.

GATT Article III (on ‘‘National Treatment’’) establishes a general prohibition

against a WTO member engaging in activity that discriminates in favor of domestic

products at the expense of imported products. Specifically, paragraph 2 of this article states that a WTO member cannot impose taxes on imported products that are

greater than those imposed on domestic products. By rebating the amount of the

VAT burden over 3 percent or 6 percent for local products, while continuing to impose the full 17 percent VAT on imported semiconductors, the current policy violates

this basic GATT/WTO obligation.

Prior GATT decisions clearly establish that it is a violation of the national treatment principle to grant a tax credit or rebate to certain domestic manufacturers of

a product while charging the full tax rate to similar foreign-manufactured products.

This is true even if the tax credit or rebate is intended to provide a subsidy to local

producers. While China does provide the benefits to both domestic and foreignowned facilities in China, the different treatment of domestic and imported products

is a violation of its national treatment commitment. Any tax imposed on imported

goods must be collected in a non-discriminatory manner.

The best solution for U.S. export interests and the development of China’s information technology market is for the PRC to reduce or eliminate the VAT rate for

all semiconductors and integrated circuits, regardless of origin.

As noted above, China joined the Information Technology Agreement (ITA) and

has eliminated all tariffs on semiconductors in 2002 and will eliminate tariffs on

other information technology products in the near future. The same public policy

reasons that caused China to decide to eliminate its tariffs on semiconductors apply

with equal force to a decision to lower the VAT rate. A substantial portion of the

growth of the American economy has been attributed to information technology and

the productivity enhancements made possible by advances in semiconductor technology and production. Just as it was in China’s interest to eliminate all import

tariffs on semiconductors, significant reduction in the VAT rate imposed on all semiconductors would contribute to the growth of the Chinese IT market and would

benefit the Chinese economy in general. In addition, reports indicate that China’s

elimination of semiconductor tariffs (formerly 6–12 percent) has succeeded in reducing smuggling of semiconductors into China. As the high VAT rate on semiconductors provides an incentive for smuggling, this runs counter to the high priority the

Chinese government has placed on eliminating illegal entry of goods.

Although it is not designed to do so, the high VAT rate imposed on semiconductors imposes significant costs on Chinese electronics producers on exports from

China. While China ostensibly rebates the VAT on semiconductors and other electronics components when the finished product containing the inputs is exported,

many exporters from China have been unable to receive the full amount of the rebate officially due to them because provincial and local authorities may refuse to

rebate VAT charges collected by another jurisdiction within China.

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3 Council for Trade-Related Aspects of Intellectual Property Rights; Responses from China to

the Questions posed by Australia, the European Communities and their member States, Japan

and the United States; IP/C/W/374 10 September 2002; Page 43.

There have been several noteworthy developments on the VAT rebate issue this

year. First, there is the growing recognition in Washington as well as in other world

capitals that China’s VAT rebate program is a violation of the WTO. In March, 32

Members of the U.S. House of Representatives sent a letter to Ambassador Zoellick

stating ‘‘We believe China should eliminate the VAT for all semiconductors regardless of origin and we encourage you to continue to press for a speedy resolution of

this violation.’’ In June, 21 U.S. Senators sent Ambassador Zoellick a letter stating ‘‘We urge you to continue to vigorously insist that China lower its VAT on semiconductor imports to abide by its World Trade Organization (WTO) commitments . . .’’ Many of you on the Commission signed these letters, and we appreciate the continued support of Congress on this issue.

In May, the World Semiconductor Council (WSC) issued a joint statement critical

of China’s VAT rebate program. The WSC is composed of CEOs from companies representing the European Semiconductor Industry Association (EECA–ESIA), Japan

Electronics and Information Technology Industries Association (JEITA), Korea

Semiconductor Industry Association (KSIA), Semiconductor Industry Association

(SIA), and Taiwan Semiconductor Industry Association (TSIA). The WSC stated:

‘‘. . . under China’s current application of its Value Added Tax (VAT), a VAT

of 17 percent is applied to all semiconductors, but companies designing and

manufacturing semiconductors in China are eligible to receive a substantial rebate of the VAT paid on those semiconductors. This reduces the effective VAT

burden on domestically designed and produced semiconductors to only 3 percent. Discrimination has the effect of limiting market access, distorting patterns

of trade and investment, and negates the benefits China promised to provide

when it joined the WTO. The WSC calls for China to lower its VAT rate to 3

percent for all semiconductors, regardless of origin.’’

A second key development is USTR’s formal inquiries to the Chinese on this subject. Coupled with the interest on Capitol Hill and the WSC, USTR’s request that

China address the VAT rebate problem has attracted the attention of Chinese government officials. As a result of this attention, China has formed a research group

to re-examine the VAT issue. In SIA’s recent meetings in China, we sensed a willingness in some quarters to explore alternatives with the U.S., but in other quarters, continued skepticism that changes were necessary. The U.S. government must

continue to insist that China quickly come into compliance with GATT article III.

Lowering the VAT for both domestically produced and imported semiconductors

would be a non-discriminatory policy that is in China’s interest for all the reasons

set forth above. Non-discriminatory application of the VAT rebate for all semiconductors would allow Chinese electronics producers to obtain the most advanced

technology available worldwide at the most competitive prices, benefiting Chinese

consumers and the entire Chinese economy, as well as encouraging growth in China’s IT sector.

INTELLECTUAL PROPERTY PROTECTION

SIA would like to underscore the importance of China’s full compliance with its

commitments to improve intellectual property (IP) protection. This is critical not

only to U.S. firms doing business in China, but also in China’s self interest, as it

will encourage the high technology foreign investment China seeks in order to promote the development of its economy while simultaneously encouraging local entrepreneurs to engage in innovation.

Before discussing the issue of enforcement, let me begin by congratulating China

for its success in resolving one issue related to its semiconductor layout design protection law. In March 2001, China’s State Council passed Regulation on Integrated

Circuit Layout Design Protection, which took effect October 1, 2001. Last year, a

senior official of the Ministry of Information Industry made comments indicating

that China’s new law did not cover discrete semiconductors. SIA objected to this interpretation because the WTO TRIPs agreement is clear that discretes, which are

products with only one active element, are to be protected. We are pleased to report

that, in a response to a question posed by the United States, China affirmed before

the Council for Trade-Related Aspects of Intellectual Property Rights that ‘‘With

respect to discrete mentioned in the question in particular, if it complies with provisions of Article 2 and Article 4 of the Regulations on the Protection of Layout Designs of Integrated Circuits, it can be protected through applying for registration of

layout-design.’’ 3 We believe that this resolves the discretes issue, and again express

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our appreciation the USTR and Chinese government for their efforts to bring this

question to a satisfactory conclusion.

SIA would like to highlight the need for strengthened IP enforcement. IP protection is important not only in China, but in all markets around the globe. The World

Semiconductor Joint 2003 Statement, referenced above, emphasized the need for

strong intellectual property protection around the world, stating:

‘‘Semiconductor makers must invest a very high percentage of sales in R&D,

and the intellectual property that results is the lifeblood of the company. Failure

to adequately protect intellectual property is very damaging to the semiconductor industry. There are an increasing number of instances of counterfeiting

of IC’s and other semiconductors. One form of counterfeiting is the unauthorized

direct optical copying of the chip, and reproduction of a mask work (layout

design/topography) based on the optical copying, and then fabrication of a semiconductor based on this mask work and sale under a different company’s name. Another form of counterfeiting involves reverse engineering a company’s chip,

and then producing a physically identical chip and selling it without authorization under the original company’s name and trademark. Both types of counterfeiting must be quickly addressed and stopped.’’

The World Semiconductor Council is now working on a proposal to establish fast

track consultative mechanisms to encourage enforcement actions to counter IP violations, and to encourage manufacturers to develop policies to prevent their inadvertently making semiconductors that violate a third party’s IP. We are hopeful that

this proposal will be adopted in all semiconductor producing regions around the

world.

SIA is aware of numerous reports of IP violations in China. In one typical case,

an SIA member company found that Chinese firms were making identical copies of

its chips and data sheets, and selling it under the Chinese company’s name. Under

TRIPs, reverse engineering a chip to design an original and better product is allowed under the layout design laws. However in this case the chips were essentially

photocopies of the U.S. design, which we know because the pirate included the U.S.

company’s part number etched in a submask level and unused circuits that the U.S.

firm had placed on the chip to reserve space for future product development. The

Chinese firms that engage in piracy are typically thinly capitalized companies that

contract the manufacture of the copied chips to foundries that can afford to make

the necessary capital expenditures.

China’s court system is still developing, and U.S. firms are concerned about the

fairness of its procedures. For example, we understand that only ‘‘legitimate’’ purchases are actionable. These rules put an unreasonable burden on U.S. firms who

cannot hire a private investigator to purchase the counterfeits, but must instead

find purchasers of the counterfeit product and convince those purchases to sign a

statement that they bought the counterfeit goods. China also has administrative enforcement mechanisms, but these are largely untested.

In the aforementioned letter signed by 32 House members, the Representatives

stressed that ‘‘the improved laws China put in place to protect IP are useless unless

they are supported by transparent, standardized and predictable court procedures

that make the judicial system accessible . . . We must continue to demand that

China immediately upgrade its IP enforcement mechanisms so that foreign semiconductor companies have certainty their products are protected in this emerging market.’’ The letter signed by 21 Senators to Ambassador Zoellick stated ‘‘We encourage

you to continue to press for strengthened enforcement to bolster the credibility of

[the IP] laws, and to explore with your Chinese counterparts alternative solutions

such as fast track investigations of alleged piracy.’’ Given its importance to both

U.S. producers and China’s economic development, SIA urges USTR and the Chinese government to continue to make IP enforcement a high priority issue.

TRANSPARENCY

Several commitments in the final protocol of accession are expected to improve

transparency in China’s administrative rulemaking. For example, China has agreed

that only those trade-related measures that are published and readily available will

be enforced. China has also agreed to make information on trade-related measures

available to WTO members upon request before those measures are implemented or

enforced.

Additionally, China has committed to establish or designate an official journal for

the publication of all trade-related measures and to provide a reasonable period of

time for comment to the appropriate authorities before measures are implemented.

China is considering providing this information in English in order to provide transparency to the international business community, and to post the information on the

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web. These are important steps in improving transparency. SIA urges China to fully

implement these measures.

LOCALIZATION

There had been localization requirements for parts and materials for products

made in China which, while not technically legal requirements, imposed serious restrictions on firms’ ability to utilize imported parts. Firms had been required to file

localization plans with their foreign investment application. The Chinese government also audited foreign firms to determine local content. What constitutes local

content can be subject to many definitions. For example, importation via a Chinese

distributor can qualify a part as ‘‘local.’’ Chinese sectoral industrial policies also contain local content requirements. Prior to its accession to the WTO, China had imposed local content requirements on products containing semiconductors.

In our discussions with Chinese officials, there was a recognition that these policies are inconsistent with China’s WTO obligations and would be repealed in time.

SIA again calls for the immediate repeal of all local content policies as required by

the terms of the WTO accession agreement.

During the China WTO accession negotiations, the Chinese government confirmed

that China would ensure that all state-owned and state-invested enterprises would

make purchases and sales solely on commercial considerations, e.g. price, quality,

marketability, availability, and that the enterprises of other WTO members would

have an adequate opportunity to compete for sales to these enterprises on a nondiscriminatory basis. In addition, the Chinese government committed that it would

not influence commercial decisions on the part of state-owned or state-invested enterprises. Adherence to these commitments will be critical for China’s development

because it will ensure that Chinese electronics firms are able to purchase the most

competitive chips free from political interference. Given the market access problems

that the U.S. historically faced in other semiconductor markets, it is also critical to

U.S. export interests that China’s state-invested enterprises purchase solely on a

commercial basis.

CONCLUSION

China is a large and fast growing market. The economics of our industry dictate

that U.S. firms, to remain competitive, must be able to compete on a fair and open

basis for sales in China. For this reason, we are very encouraged by China’s efforts

to implement its WTO commitments, but we are concerned over the remaining existence of barriers and impediments to trade in China. While the challenge of promoting economic development in a country the size of China is immense, we are

encouraged by China’s progress and are hopeful that China will lower its VAT for

all semiconductors, vigorously enforce its IP laws, eliminate its local content requirements, and improve transparency.

SIA thanks the Commission for the opportunity to testify today. We look forward

to continuing to work with the U.S. Government on these important issues.

PREPARED STATEMENT OF WILLIAM PRIMOSCH

SEPTEMBER 24, 2003

Mr. Chairman and Members of the Congressional-Executive Commission, Thank

you for giving the National Association of Manufacturers (the NAM) to testify on

a subject of great interest to U.S. manufacturers.

The NAM represents 14,000 manufacturing companies, both large multinational

corporations and over 10,000 small and medium-size firms. I can tell that we hear

more from our members about trade with China than with any other foreign country.

Trade with China is of immense importance for U.S. manufacturers both because

China’s growing economy of 1.2 billion consumers offers a major market for U.S.

products and because China is also an increasingly vigorous competitor in the U.S.

and global marketplace.

The Chinese market is set to become one of the largest in the world within the

next several years. Chinese imports are expected to exceed $380 billion in 2003,

making China the world’s third largest importer after the United States and Germany. At the same time, China is rapidly becoming a major exporter of industrial

goods, and the range of industrial products exported has continued to grow at a

rapid pace. China’s expanded participation in the global marketplace, then, offers

both new commercial opportunities as well as challenges resulting from increased

competition in the U.S. and foreign markets.

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Many NAM members, notably large multinational corporations, have developed

important commercial relationships in China and seek to expand their share of the

Chinese market. At the same time, a large number of members, particularly small

companies, have expressed concern about increased import competition from China

in the United States and currency and trade practices that give Chinese producers

an unfair advantage.

In several meetings on China over the past year, our members have told us that

they want the United States to have a positive trade relationship with China. However, they also want a level playing field for competition. Manufacturers want the

U.S. Government to deal firmly with unfair Chinese trade and currency practice.

And they want the U.S. government to advance the long-term goal of providing U.S.

companies with the same kind of access for U.S. goods and services in the Chinese

market that Chinese goods and services enjoy in the U.S. market.

U.S. manufacturers view China’s membership in the WTO, which became effective

in December 2001, as an important positive development. As a WTO member, China

has now committed to abide by the same international trade rules that apply to the

United States and most other countries. In addition, it has made significant commitments to open its internal market to foreign products and services in areas where

the United States is highly competitive. The NAM supported China’s membership

and Permanent Normal Trade Relations (PNTR) status on the condition that China

would adhere to these commitments and become a responsible participant in the

international trading system.

As China concludes its second year as a WTO member, its compliance record is

decidedly mixed. While U.S. exports to China continue to increase (by 24 percent

in January–June 2003) and a growing number of U.S. companies are trading and

investing there, the NAM has also received far more complaints about unfair Chinese practices than in the previous year.

NAM members recognize that China is still in transition to a market economy and

in the process of phasing in certain WTO market-opening commitments. However,

because China has quickly become such an important global importer and exporter,

it is vital that the United States work to ensure that China complies with all WTO

obligations and particularly those that have a significant impact on U.S. economic

interests.

CHINESE POLICIES THAT PROVIDE UNFAIR ADVANTAGES AND CREATE NONTARIFF

BARRIERS

In a recent survey, our members identified a variety of policies that have provided

Chinese exporters with unfair trade advantages and created significant nontariff

barriers that hinder market access for U.S. products in China. In the view of many

manufacturers, China’s undervalued currency is the single most important factor

because it affects all Chinese exports and imports. Other policies also serve to limit

U.S. exports to China and give Chinese products in the United States a competitive

advantage. Taken together, these policies are making a significant contribution to

the U.S.-China trade imbalance, which was $103 billion in 2002 and could reach

$130 billion in 2003. The following section provides more details on individual issues

of concern.

CURRENCY MANIPULATION

By far, the NAM has received the greatest number of complaints about China’s

deliberate policy of undervaluing its currency to gain unfair competitive advantage

over U.S. producers and those of other WTO member countries. Economists have estimated that China’s currency could be undervalued by 40 percent or more. The Chinese yuan has remained pegged to the dollar at 8.28 for the past 8 years despite

an extended period of robust economic growth, continuing trade surpluses and a

large buildup in foreign exchange reserves, which exceeded $350 billion in July

2003. This level of foreign exchange reserves is, according to IMF analysis, far in

excess of what would be required to cushion China’s balance of payments from normal fluctuations in trade and investment flows.

Pegging the yuan to the dollar appears to be part of a deliberate strategy to support Chinese industry and boost exports. This kind of currency undervaluation for

commercial gain goes against the intent of the General Agreement on Tariffs and

Trade (GATT), which seeks to remove trade barriers and allow markets to determine trade flows. Article IV, for example, states that ‘‘Contracting Parties shall not,

by exchange action, frustrate the intent of the provisions of this Agreement . . .’’

China’s undervalued currency acts as an additional trade barrier to U.S. exports

and an unfair subsidy for all Chinese exports. We believe that Chinese exchange

rate policies are not in accord with WTO obligations.

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The NAM appreciates efforts by the Bush Administration, particularly Treasury

Secretary John Snow, to raise the importance of market-based exchange rates with

Chinese leaders and obtain unprecedented support from other finance ministers in

the G–7 and APEC. We are confident that a more flexible market-based exchange

rate would result in a significant appreciation of the yuan against the dollar and

help to level the playing field with Chinese producers both here at home and in the

global marketplace. We strongly urge the Administration to continue to press the

Chinese government to break the current peg and allow the yuan to move up to its

true market value.

SUBSIDIZED EXPORTS

We continue to receive reports from different industries (e.g., tool-and-die, metal

forming, steel and chlorinated isocyanurates) that Chinese products are being sold

in the United States at prices so low that they could not even cover the cost of raw

materials and shipping much less full production and marketing costs. A tool-anddye company, for example, reports that a Chinese competitor was selling a product

similar to one made in the United States for $40,000, compared to the U.S. producer’s price of $100,000. The U.S. company maintains that the cost of the raw

materials alone would amount to $40,000, not including shipping, duties and other

costs. A U.S. producer of chlorinated isocyanurates, which is used as a cleaning

agent in swimming pools, reports a similar situation. As a result of pricing which

appears to be below cost, Chinese exporters are expected to increase exports of this

product by 400 percent in 2003 over 2002 levels.

These reports suggest the possibility of widespread use of subsidies, either direct

or indirect, to help Chinese exporters gain unfair competitive advantage in the U.S.

market. They merit further investigation by USTR and the Department of Commerce. One source of indirect subsidy is continued bank lending to money-losing and

insolvent Chinese manufacturers, often state-owned or state-controlled enterprises.

Since the Chinese banks providing these loans are either state-owned or state-controlled, the Chinese government bears responsibility for their lending practices. U.S.

steel producers note that the Chinese steel industry is the largest recipient of interest rate subsidies authorized by the national government. Since many of the companies that benefit from either directed bank lending or subsidized interest rates are

engaged in international trade, they have an unfair competitive advantage vis-a`-vis

U.S. based companies, which must rely on private financing at market rates.

COUNTERFEITING AND INEFFECTIVE ENFORCEMENT OF IPR PROTECTION

While Chinese laws on intellectual property rights (IPR) have improved considerably, the lack of effective enforcement of the IPR protection remains a serious problem. Violations of trademarks through product counterfeiting is rampant and on a

massive scale. The violations involve a wide range of products, including consumer

hygiene and health care products, athletic footwear, pharmaceuticals, food and beverages, motorized vehicles and even entire automobiles. Pharmaceutical counterfeiting is now, according to U.S. industry representatives, a serious public health

concern in China. We believe that the lack of criminal penalties for counterfeiting,

including jailing, prevents effective enforcement of trademark and labeling violations.

We are also concerned about reports that local government authorities are actually promoting the expansion of local industry dedicated principally to counterfeiting. At a minimum, local authorities are knowledgeable of counterfeit production

and taking no action to halt it. There appears to be no mechanism for the national

government to prevent local governments from aiding and abetting counterfeiting by

local industry. In addition, a member has reported that the Chinese customs service

has not cooperated in blocking exports of counterfeit products even when solid evidence of counterfeiting was provided. It is claimed that, since the ‘‘exporting’’ of

counterfeit products does not constitute a ‘‘sale’’ of the products, the relevant Chinese law did not apply.

Other IPR violations are also common. They include unauthorized duplication of

computer software, music and films; copying of designs; unauthorized use of patented technology; and unauthorized use of U.S. product certification logos. The makers

of air conditioning and refrigeration equipment note that the ARI (Air-Conditioning

and Refrigeration Institute) certification symbol was being used without authorization by a Chinese company. Efforts to have the Chinese government stop this unauthorized use proved ineffective.

The pharmaceutical industry does, however, also report improvements in intellectual property protection, notably by the promulgation of a new regulation on data

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exclusivity for clinical trials, as required in TRIPS and committed in China’s accession package.

MANIPULATION OF VAT AND OTHER TAXES

We have reports that China is manipulating the application of taxes, notably the

Value-Added Tax (VAT), to both restrict imports and indirectly subsidize exports.

For example, the scrap recycling industry has told us that Chinese users of imported copper and other scrap metals are deliberating undervaluing their invoices

to pay less VAT on the imported metal. When the finished metal products are exported, however, Chinese producers claim a rebate of the VAT based on the metals’

real import price. This results in a substantial subsidy for the exported product that

translates into lower prices in the U.S. market. It also enables Chinese scrap metal

users to pay higher prices for scrap metal than their U.S. competitors. Chinese customs and tax authorities have not taken action to investigate these practices.

We are also concerned about continuing Chinese discrimination in the application

of the VAT on imported and domestically produced semiconductors. China levies a

17 percent VAT on imported integrated circuits. Domestically designed and produced integrated circuits are taxed at VAT rates ranging from 3–6 percent. Integrated circuits produced in China but designed abroad are taxed at 11 percent. This

discriminatory treatment of domestic and foreign ‘‘like’’ products violates Article 3

of the GATT.

UNJUSTIFIED LABELING REQUIREMENTS

In 2002 the Chinese Ministry of Health promulgated a new regulation mandating

the labeling of all genetically modified (GM) food products. While the implementation

of the regulation was subsequently suspended indefinitely, the fact that it remains

on the books is already having significant adverse economic effects and creating barriers to trade. Some producers have ceased shipping these products in anticipation

of the regulation going into effect.

U.S. food producers have questioned whether the Health Ministry’s action was in

conformity with China’s WTO obligations. The ministry did not provide a justification for the labeling requirement based on an assessment of health risks, which is

a requirement of the Agreement on Sanitary and Phytosanitary Measures. The

Technical Barriers to Trade Agreement (TBT) also suggests inadequate attention to

the treatment of ‘‘like products,’’ the question of whether the labeling requirement

addresses a ‘‘legitimate objective’’ and the requirement to base technical regulations

on ‘‘performance’’ rather than ‘‘design’’ characteristics.

INAPPROPRIATE STANDARDS AND CONCERNS ABOUT CCC MARK SYSTEM

Several NAM members have raised concerns about application of technical standards and the CCC Mark system. With regard to standards, China is requiring that

certain products (e.g., electrical products) be manufactured only to ‘‘international

standards’’ as determined in the ISO or IEC. Other ‘‘international standards,’’ notably those developed in the United States and widely used in the global marketplace,

are not allowed. This does not conform with the WTO TBT Committee interpretation that ‘‘international standards’’ need not be limited to ISO or IEC standards.

A second set of standards concerns relates to the CCC mark system. China introduced the CCC mark system to comply with WTO requirements for a single mark

for like domestic and imported products. It is, in that sense, a step forward on

standards and mark requirements. However, the inconsistent, non-transparent and

inflexible application of the CCC Mark on a variety of products (e.g., electrical products, air conditioning and refrigeration equipment, and tires) has created market

access barriers and needlessly raised the cost of importing products into China.

Generic problems include: the high cost of having Chinese inspectors audit factories in the United States and other foreign countries on compliance with the

standards; continued delays in allowing U.S. testing and certifying bodies to certify

compliance for the CCC mark; and lengthy delays and relatively high cost of obtaining testing and certification for the CCC mark in China.

Several other specific problems were noted. A major tire company reported that

several types of its bus tires that are standard sizes in countries around the world

cannot obtain the required CCC mark because these sizes are not listed in the Chinese National Standards. Another type of tire used widely on Chinese trucks is also

not on the list and thus cannot be sold by the U.S. company in China. Efforts to

resolve this problem with Chinese standards authorities and Chinese customs have

thus far been unsuccessful. In addition, the company reports that local inspection

offices appear to be abusing their authority by requiring the re-inspection of the

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company’s Chinese-produced tires and confiscating tires which they determine to be ‘‘non-compliant’’ with the CCC mark standards.

RESTRICTIONS ON TRADE RIGHTS OF JOINT VENTURES

China is not fulfilling its commitment to allow foreign joint ventures to import

and sell products (e.g., tires, automobiles, auto parts and industrial equipment) in

China, which was to have gone into effect on Dec. 10, 2002. A major tire company,

for example, reports that the Chinese government has imposed additional restrictions on its trading rights that were not anticipated when this concession was negotiated. They include allowing only new joint ventures to have this right and requiring

the Chinese and foreign partners to have separately done U.S. $30 million in trade

with China over each of the 3 preceding years.

LACK OF ACTION ON AUTO FINANCING REGULATIONS

The Chinese government has committed to publish new regulations governing the

financing of automobile purchases. Several NAM member companies have expressed

concern about slow progress on the regulations that were explicitly promised in China’s accession agreement. The U.S. government should press for their prompt

issuance to comply with WTO obligations.

LACK OF TRANSPARENCY IN TRADE REGULATORY PROCESS

Many companies complain about the lack of transparency in the trade regulatory

process and the difficulty in obtaining current laws and regulations governing trade

and business operations. This is a continuing problem that should lend itself to solutions in a relatively short time frame. The U.S. Government should press for concrete steps that improve transparency at all levels.

POLICY CHANGES NEEDED BY THE U.S. GOVERNMENT

U.S. agencies, particularly the Department of Commerce, Office of the U.S. Trade

Representative and Treasury Department, have made good efforts to advance U.S.

trade interests with China. Both Commerce and USTR are actively monitoring China’s compliance with its commitments to abide by WTO rules and open its internal

market in accordance with the provisions negotiated in the WTO membership agreement. They have welcomed input from the business community to assist in their

analysis and assessments. The Treasury Department has also made important efforts to raise manufacturers’ concerns about China’s undervalued currency.

The scope of the challenges in China, however, requires a much larger-scale effort

than currently exists, with additional resources to address unfair trade and

currency practices and support effective promotion of U.S. exports. The NAM recommends the following policy actions to meet these challenges:

1. Seek full WTO Compliance.—The U.S. Government must ensure that China complies with its commitments as a new World Trade Organization member to follow

all international trade rules and open its internal market in accordance with specific benchmarks set forth in its membership agreement. Commerce and USTR

need additional resources to monitor and fully investigate WTO compliance concerns and market access problems. Current resources are inadequate to the task.

2. Stop Currency Undervaluation.—We must continue to press China to end the

manipulation of its currency and allow the yuan/dollar exchange rate to be determined by the market forces. Secretary Snow’s visit was an excellent start in raising the issues, but we need to keep the pressure on China and get other affected

countries (e.g., our G–7 partners) to join us. The NAM is prepared to support a

Section 301 trade complaint in concert with other members of the Sound Dollar

Coalition as a way of underscoring the seriousness of the matter and the need for

a credible Chinese response.

3. End Subsidized and Non-Market Production.—We hear too many reports from

NAM members that Chinese imports are far below the cost of production based

on international prices for raw material inputs. These charges merit more detailed

investigation. In our dialog with China, we must insist that the prices of traded

goods are determined by real economic costs and not costs artificially set by the

government.

4. Address Counterfeiting and IPR Violations.—We must take firm actions to end

China’s rampant counterfeiting of U.S. and other foreign products. Today China

is the epicenter of world counterfeiting, costing us tens of billions of dollars in lost

exports and the related jobs. At both the national and local levels, the Chinese

government is ignoring the blatant counterfeiting of U.S. products and taking no

action to prevent this. The U.S. Government needs to engage in a frank dialog

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with Chinese authorities on the need to address the problem of counterfeiting and

other intellectual property rights violations and take action under U.S. trade law

when problems are not resolved.

5. Expand Export Promotion to Support U.S. Business.—Finally, the United States

needs to undertake a large-scale joint public-private export trade effort to increase

U.S. exports to China. In 2003, China is set to become the world’s 3rd largest im- porter ($380 billion) but the United States only has an 8 percent share of all Chinese imports. U.S. companies need to increase their marketing efforts but greatly

expanded Commerce Department and other promotion assistance is also needed.

We recommend a network of low-cost American business centers throughout

China to help U.S. companies overcome the many unique barriers to doing business in China (e.g., language, cultural, communication and infrastructure) and access rapidly growing urban areas in the country’s interior.

A balanced strategy that emphasizes stricter compliance with trade rules, an end

to currency undervaluation and improved market access will not only help U.S.

manufacturers compete on a level playing field but also place the U.S.-China trade

relationship on a more stable footing for long-term development.

Thank you for giving the NAM the opportunity to testify today.

PREPARED STATEMENT OF LAWRENCE J. LAU

SEPTEMBER 24, 2003

Mr. Chairman, Mr. Co-Chairman, distinguished commissioners, ladies and gentlemen. It is a great honor for me to have the opportunity to testify before your Commission. As recommended by your Commission staff, I shall focus on the U.S.-China

trade imbalance and whether the imbalance can be corrected by a revaluation of the

Renminbi, the Chinese currency, vis-a`-vis the U.S. Dollar.

The Chinese trade surplus in goods and services vis-a`-vis the United States is

large and growing. Official U.S. data overestimate the Chinese surplus and official

Chinese data underestimate the Chinese surplus because of their different treatments of re-exports through Hong Kong and other trans-shipment points. Prof. K.C.

Fung, of the University of California at Santa Cruz and I have adjusted the data

of both countries and derived adjusted estimates of the U.S.-China trade imbalance.

For 2002, our best estimate of the Chinese trade surplus for goods and services combined is US$74.3 billion (see Appendix Table 1).

However, despite the large Chinese trade surplus vis-a`-vis the United States, the

overall Chinese trade surplus with the World as a whole is relatively small, and has

been becoming smaller, especially after Chinese accession to the World Trade Organization (WTO). It is projected to be approximately US$10 billion for 2003, or 1.5

percent of total Chinese international trade. This implies that China will have a

trade deficit with the rest of the World, which is projected to be on the order of

US$70 billion for 2003. The trade surplus vis-a`-vis the United States is projected

to be in the US$80 billion range.

In contrast, Japan has a large trade surplus both with the United States and the

World as a whole. For 2002, Japan has a trade surplus of approximately US$62 billion with the United States and a trade surplus of approximately US$80 billion with

the World as a whole. Its balance of payments, on a current-account basis, is thus

much more out of equilibrium than China’s.

Moreover, the Chinese exports to the United States have mostly originated from

foreign- (including U.S.) invested enterprises in China or Chinese subcontractors to

foreign firms and are the direct consequences of the rapid expansion of global

outsourcing and division of labor made possible by the revolution in information and

communication technology. In addition, a large proportion, over 50 percent, of the

Chinese export operations consists of ‘‘processing and assembly’’ activities—the final

assembly/finishing of products using intermediate inputs produced elsewhere. What

used to be exported from Japan, Hong Kong, South Korea and Taiwan to the United

States are now increasingly finally finished and exported from China, using components and parts supplied by these economies and elsewhere. The continuing growth

of the Chinese trade surplus with the United States is a direct consequence of the

shifting of the location of final assembly/finishing of many goods from these East

Asian economies to China. The finished goods are considered to have originated

from China when they are exported to their final users from China. As a result, simultaneous with the rise of the Chinese trade surplus with the United States, the

trade surpluses of these other East Asian economies vis-a`-vis the United States decline, or stop growing, and the trade surpluses of these economies with China rise.

In other words, a significant part of the trade surpluses that these economies once

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1 In addition, the United States has a surplus in trade in services of more than US$ 2 billion,

and there the domestic value-added content is almost 100 percent.

had with the United States have been shifted to and ‘‘inherited’’ by China (see Appendix Table 2). For example, during the first half of 2003, China had trade deficits

of US$7 billion, US$10 billion, US$18 billion and US$7 billion with Japan, South

Korea, Taiwan and the ASEAN countries respectively (see Appendix Table 3). The

Chinese trade deficit in goods and services vis-a`-vis the rest of the World may be

expected to continue to rise in the future because of the rapid growth of oil imports

(driven by rapidly increasing domestic demand for automobiles) and outbound tourism.

However, precisely because the Chinese firms are mostly engaged in assembly/finishing operations, despite the high gross value of Chinese exports, the domestic

value-added content of Chinese exports to the United States is low—it may be estimated at 20 percent. (Equivalently, the import content of Chinese exports to the

United States is a high 80 percent.) The domestic value-added content of Chinese

exports to the World is higher, at 30 percent. Chinese exports to the United States

may be estimated to be no more than 10 percent of Chinese GDP. (Chinese exports

to the World are not quite 30 percent of Chinese GDP.) Thus, the Chinese GDP attributable to Chinese exports to the United States is no more than 2 percent. The

percent of Chinese GNP attributable to Chinese exports to the United States is most

likely even smaller because most of the profits from such exports accrue to the foreign shareholders and owners of the exporting enterprises and clients of Chinese

subcontractor firms.

Yet, this global outsourcing of the assembly/finishing operations, which require

relatively low skill levels, to the lowest cost subcontractors, also strengthens the

competitiveness of U.S. firms in their home markets and helps them to not only

maintain their existing markets but also open new markets for U.S. products in the

rest of the world. For examples, Dell may not have been able to compete with Acer

without the cost savings resulting from the final assembly of its personal computers

in China (typically by its contractor); Motorola may not have been able to compete

with Samsung without its production and export base for mobile telephones in

China; and Hewlett-Packard may not be able to compete with Epson without manufacturing overseas. Competition is worldwide today and not just limited to U.S.

markets. However, as mentioned previously, the Chinese value-added is very low because almost all components and parts, especially the high-value ones, are imported.

Thus, while China may have the dubious honor of being the world’s largest shoe

manufacturer, Nike has become the world’s most profitable footwear firm without

manufacturing a single pair of shoes. More generally, the global outsourcing enables

U.S. firms to both maintain their domestic market shares and expand their global

market shares and thereby maintain, create and expand better-paying job opportunities in the United States. The bulk of the jobs won by Chinese workers as a result

of global outsourcing were from the other East Asian economies, and not from the

United States—we lost those decades ago.

The fact that Chinese exports have a low domestic value-added content has a couple of important implications. The first has to do with the relative gains from trade.

The domestic value-added content of Chinese exports to the United States, as mentioned above, is only 20 percent. The domestic value-added content of U.S. exports

to China is much higher. (The top 5 U.S. exports to China in 2002 are: (1) Aircraft

and associated equipment; (2) Thermionic, Cold Cathode and Photocathode Valves;

(3) Telecommunication Equipment; (4) Oil Seeds and Oleaginous Fruit; and (5)

Measuring/Checking/Analysing Instruments.) The adjusted Chinese exports to the

United States is approximately US$105 billion, f.o.b. and the adjusted U.S. exports

to China is approximately US$27.5 billion, f.o.b. If we assume the U.S. domestic

value-added content is 60 percent, then the domestic value-added of Chinese exports

to the United States is US$21 billion and the domestic value-added of U.S. exports

to China is US$18.5 billion. These two numbers are not that far apart and 60 percent may well be an under-estimate of the domestic value-added content of U.S. exports to China. In terms of value-added created in each country, the gains from

trade between U.S. and China seem not to be too inequitably distributed.1

The second has to do with the potential effectiveness of a revaluation in the exchange rate of the Renminbi, the Chinese currency, in reducing Chinese exports to

the United States and thereby stemming the loss of jobs. The low domestic valueadded content of Chinese exports to the United States implies a high import content. Thus, a revaluation of the Renminbi, while it raises the cost of processing and

assembly in China, also lowers the cost of the imported intermediate inputs, which

constitute 80 percent of the total cost of the product, at the same time. A 10-percent

revaluation will therefore increase the cost of Chinese exports to U.S. importers by

approximately 2 percent. It is therefore unlikely to have a significant effect in reducVerDate 11-MAY-2000 10:53 Dec 19, 2003 Jkt 000000 PO 00000 Frm 00152 Fmt 6601 Sfmt 6621 90833.TXT China1 PsN: China1
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ing Chinese exports to the United States. The postwar Japanese experience is hardly encouraging on this question. The Japanese Yen appreciated from 360 Yen/US$

in the early 1960s to its current 115 Yen/US$, but the revaluation did not seem to

have reduced the Japanese trade surplus vis-a`-vis the United States. Mere revaluation of an exchange rate seldom works and will not in this case. It is far more

important, and effective, to change the mercantilist mindset prevalent in these

countries.

There are also additional reasons why a revaluation of the Renminbi is unlikely

to help very much. Most macroeconomists will tell us that our trade deficit is the

direct consequence of our savings-investment imbalance, that unless we save more

and consume less, the balance of payment deficit is likely to continue. Even if the

Renminbi is significantly revalued, and the revaluation is effective in raising the

prices of Chinese exports, it may merely lead to diversion of processing and assembly activities from China to third countries with similarly low costs.

China and the United States do not compete in any export markets. The U.S. does

not export anything that China exports. Similarly, China does not export anything

that the United States exports. The two economies are actually quite complementary. In terms of reducing the U.S. trade deficit, it is far more effective to have a

revaluation of the currencies of countries that compete directly with the United

States in export markets, which should increase U.S. exports. For third countries

like China, it is not the values of their exchange rates vis-a`-vis the U.S.$ that determine whether they will buy from Airbus or Boeing, it is the Euro/US$ exchange

rate. Finally, a precipitous revaluation of the Renminbi may lead to a flight from

the US$ by Chinese nationals, possibly driving up the rate of interest in the United

States.

We may note that both Dr. Glenn Hubbard, the former Chairman of the Council

of Economic Advisers, and Dr. Gregory Mankiw, the current Chairman of the Council of Economic Advisers, have said that a revaluation of the Renminbi is unlikely

to be very effective in reducing job losses in the United States.

Revaluation of the Renminbi, even unaccompanied by the removal of outbound

capital control, is also likely to pose some risks to the financial institutions and enterprises in China because of the requirement of ‘‘marking to market.’’ For example,

the People’s Bank of China (PBOC), the central bank, holds approximately US$360

billion of foreign exchange reserves, with perhaps more than 70 percent of which

denominated in US$. It will have to take a massive write-down in Renminbi terms

upon revaluation. (PBOC holds approximately US$126 billion of Treasury securities,

and also Fanny Mae and Freddy Mac securities.). It has been estimated that an additional US$150 billion are held by Chinese enterprises and households as deposits

at Chinese commercial banks. A full-fledged banking crisis may ensue if Chinese

commercial banks have to write down their currency losses.

It is probably counterproductive for the United States to demand that China do

something that is costly to China but does not do the United States any good. Forcing China to revalue does not really help us solve our job problem fundamentally.

We next address the question of whether the market for foreign exchange in

China is in equilibrium (a related question is whether the Renminbi is undervalued). There actually has been a cumulative real exchange rate appreciation of the

Renminbi versus the U.S. Dollar of approximately 15 percent since January 1, 1994.

The Chinese current accounts are at the present time approximately balanced visa`-vis the World as a whole despite large surpluses vis-a`-vis the United States, with

only a small surplus of approximately US$10 billion expected for 2003. However, the

Chinese overall balance of payments is in disequilibrium with a significant surplus,

mostly because of the large capital inflow on account of the inbound foreign direct

investment (FDI), currently running at a rate of US$60 billion a year. But the capital accounts are in surplus also because of controls on capital outflows. Only inflows

of capital but no outflows of capital are permitted (with some exceptions) in China.

Thus, while it is true that the Renminbi exchange rate is not ‘‘market-determined’’

by spot supply and demand, whatever exchange rate that may emerge from simply

eliminating the government intervention in the foreign exchange market is not a

truly market-determined exchange rate either, because many potential buyers of foreign exchange and sellers of Renminbi have been excluded. If capital controls are

lifted tomorrow, it is not clear that the Yuan will appreciate. Dr. Nicholas Lardy

of the Institute for International Economics, Dr. Stephen Roach of the Morgan Stanley, and Dr. Weijian Shan, a General Partner of Newbridge Capital all seemed to

believe that the value of the Yuan in terms of U.S. Dollars will go down, not up,

if capital controls are lifted. I personally do not share their view. However, lifting

capital controls abruptly is extremely risky—it may trigger a massive financial crisis in China. If Chinese depositors withdraw their deposits from the Chinese commercial banks and exchange them into U.S. Dollars en masse, the commercial banks

150

may be faced with an illiquidity and insolvency crisis, because of the extraordinarily

high proportion of nonperforming loans in their portfolios. In addition, the apparently large official foreign exchange reserves held by China can be very quickly depleted, putting great downward pressure on the Renminbi. Standard and Poor, the

rating agency, supports the decision of China not to revalue the Yuan on the

grounds that a floating of the currency will damage China’s credit rating.

One can of course also try to correct the disequilibrium in the foreign exchange

market through quantity adjustments rather than price adjustments, i.e., revaluation. Quantity adjustments imply increasing the imports of goods and services, promoting outbound direct and portfolio investment, and financing inbound direct (and

even portfolio) investment with Renminbi-denominated loans. But above all, it

means changing the mercantilist/fish-trap mentality.

First, China can afford to run a significant trade deficit, given its substantial foreign direct investment inflow, and it can and should import more from the United

States. The trade imbalance can be corrected in two ways—decreasing imports or

increasing exports. Rather than making the Chinese sell less to us, it is far better

for us to encourage them to buy more from us. Given the levels of Chinese exports

and imports and external debt levels relative to its GDP, there is no need for the

Chinese central bank to continue to accumulate foreign exchange reserves. One caricature of what has been happening for the last few years is the following: Chinese

firms exchange goods for greenbacks, pieces of paper that can be printed at virtually

zero cost; they sell the greenbacks to the Chinese central bank for Renminbi; and

the central bank in turn exchanges the greenbacks for other pieces of paper, call

bonds, which can also be printed at virtually zero cost. Holding too much paper is

not without risk. At some point the Chinese should turn back some of the pieces

of paper for some real goods. Special high-end consumer products, such as HarleyDavidson motor cycles and Corvette cars, can have a significant market in China,

but require promotion. There is also always a high demand for high technology capital goods, and perhaps an expedited procedure for processing applications for export

control waiver can help. U. S. firms can also provide more services to China, in the

areas of telecommunications, transportation, logistics and distribution activities, financial services, and e-Commerce. Leisure time activities and entertainment— sports exhibition, movies, etc.—are another promising area. There is also a great

deal of room for growth in the provision of invisible/intangible ‘‘exports’’ of services— tourism (China has really opened up tourism in a big way—travelers are permitted to take US$5,000 out of the country per person per trip; individuals can now have

passports that are valid for years as opposed to just a single trip; and individual

tourism is now a legitimate reason for traveling abroad); education (more Chinese

students for universities and graduate schools in the United States), and healthcare

(medical treatment) in the United States. Finally, enhanced intellectual property

rights protection in China can greatly augment U.S. exports of goods and services

to China.

China can also offer to finance the inbound foreign direct investment (FDI) of foreign direct investors with Renminbi-denominated loans, providing a natural hedge

to foreign direct investors but at the same time reducing the inflow of foreign exchange, which China, with a savings rate of 40 percent, does not need (such loans,

however, must be with recourse to the ultimate parents in order to avoid moral hazard). China can also make it easier for foreign direct investors to repatriate their

principal and profits. Outbound foreign direct investment, especially strategic foreign direct investment, should be promoted and encouraged. For example, Chinese

textile firms may be encouraged to invest in the U.S. textile industry. There may

well be complementarities and synergies between industries on the decline in one

country but on the rise in the other. Many of the benefits and costs of international

trade can be internalized. In particular, the potentially displaced workers can be

compensated by the potential beneficiaries of the trade, who can, in turn, pass the

cost to the general public by charging slightly higher prices. Chinese firms can also

be encouraged to make strategic investments in listed and unlisted companies in the

United States and elsewhere. Tax treaties should be concluded between China and

the United States and other countries so as to facilitate Chinese outbound foreign

direct investment. China can also increase foreign aid and foreign loans to multilateral organizations and low-income developing economies—e.g., loans repayable in

the local currency.

Instead of floating their shares on the overseas markets, good Chinese firms

should be encouraged to offer their shares domestically (China does not need any

more foreign exchange), where in fact the price/earnings ratios are much higher.

China should also begin to relax its capital control by allowing regulated orderly

outflows of portfolio investments through approved instruments or vehicles, e.g.,

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2Of course, a Chinese overall balance of payments of zero, while it implies that China will

have a significant deficit in the current accounts (principally the trade in goods and services)

with the World as a whole, it does not necessarily imply that the U.S.-China bilateral trade deficit will be smaller. However, the expectation is that the overall trade deficit of the United

States vis-a`-vis the World as a whole will be reduced as China or other economies, making use

of their trade surpluses with China, increase their imports from the United States.

ed and traded mutual funds (e.g., S&P500 indeed funds), and China Depositary Receipts issued by U.S. and other foreign publicly listed companies and listed and

traded on the Chinese Stock Exchanges.

Are there other promising alternatives for reducing the disequilibrium in the overall balance of payments to a revaluation? The answer is yes. First, an acceleration

of the World Trade Organization (WTO) commitments on tariffs, market access and

opening can be extremely helpful. Second, the imposition of import tariffs by the

United States. However, this may not be very effective, because the supply of imports can simply come from another country. And discriminatory import tariffs may

not be permitted under WTO rules.

A potentially interesting idea is that of ‘‘Voluntary Export Tax (VET)’’. Export

taxes are generally permitted under WTO rules (either vis-a`-vis the United States

or vis-a`-vis the rest of the World). An export tax is better for China than a revaluation because while it enhances the terms of trade in the same way as a revaluation

but it does not lead to losses for holders of the U.S. dollars, e.g., the People’s Bank

of China or other commercial banks and enterprises that may have to recognize the

foreign exchange losses. It also does not generate windfall gains for the holders of

the Renminbi and thus does not reward currency speculators or encourage continuing currency speculation. Moreover, an export tax can be easily lifted if and

when the balance of payments conditions so warrant. For the United States and

other importers of Chinese goods, an export tax of 2 percent is equivalent to a revaluation of 10 percent. An import subsidy also has the same effects on trade flows

as a revaluation or an export tax. However, from a fiscal point of view, an export

tax is preferable because it generates revenue whereas an import subsidy requires

expenditure.

Volatility of the exchange rate is not conducive to long-term trade and investment

relations—long term effective hedges are hard to find and expensive. However, a

wider band of fluctuation around a stable mean exchange rate is a good idea but

should be introduced and implemented only when expectations of future exchange

rates are more neutral and diffuse. If expectations are all one-sided, introducing a

wider band does not help because the top of the band will be reached immediately,

possibly leading to expectations of even further movements in the same direction.

China should not revalue now, because then it will encourage continuing speculation

and pressure to revalue. Moreover, it is always easier to revalue than to devalue.

Devaluation is likely to face much more opposition than a revaluation. The U.S. may

object, assuming that it continues to be in a net deficit position. Objections and competitive devaluation by other exporting countries competing in the same markets

can be expected with a devaluation but not with a revaluation. Finally; the perception of the domestic population may pose an obstacle to devaluation because the currency is also regarded as a store of value and devaluation may be regarded as a

sign of weakness of the economy or mismanagement. When the long-term value of

the currency is uncertain, as is the case for the Renminbi, it is better to stay put

rather than revalue or devalue.

The best strategy for us is probably to focus on achieving the outcome that we

want, e.g., an overall Chinese balance of payments of approximately zero, and not

on the method for achieving it.2 We should hold China to the achievement of the

outcome, but leave the choice of instrument, or combination of instruments, to

China. We have advised the Japanese Government to revalue the Japanese Yen

quite a few times, which it dutifully did each time, but the revaluations never

achieved the desired outcome—a reduction or elimination of the large Japan-U.S.

trade surplus—the trade surplus only became bigger. We should have asked the

Japanese Government to simply reduce its overall balance of payments surplus, in

whichever way that it thinks it can.

Chinese economic policymakers are committed to the gradual evolution to a market based exchange rate determination mechanism. Going forward, the most important task facing the Chinese economic policymakers is to lay the groundwork for the

orderly and regulated relaxation of the controls on the different types of capital

outflows, with the objective of achieving an equilibrium in the overall balance of

payments. Then gradually, with the overall balance of payments continuing to be

in approximate equilibrium, additional types and higher volumes of capital outflows

can be liberalized until the ultimate objective of free convertibility is achieved.

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APPENDIX TABLES

Table 1.—Estimate of U.S.-China Trade Balance, f.o.b., Adjusted for Re-exports, Re-export

Markups and Services

(Billions of US$)

Year

Our estimate of

U.S. imports from

China fob adjusted for re-exports and re-export markups (Official U.S. data)

Our estimate of

U.S. exports to

China fob adjusted for re-exports and re-export markups (Official U.S. data)

Estimate of U.S.

exports of services to China (Official U.S. data)

Estimate of U.S.

imports of services from China

(Official U.S.

data)

Our estimate of

U.S.-China trade

balance of goods

and services (Official U.S. data)

1995 33.7 16.0 2.5 1.7 ¥16.9

1996 38.7 17.1 3.2 1.9 ¥20.3

1997 48.2 18.0 3.6 2.2 ¥28.8

1998 56.3 18.9 4.0 2.3 ¥35.7

1999 65.1 17.7 3.9 2.7 ¥46.2

2000 80.3 21.4 4.6 2.8 ¥57.1

2001 83.5 24.7 5.3 3.0 ¥56.5

2002 104.0 27.4 5.3 3.0 ¥74.3

Sources: Fung and Lau ‘‘Adjusted Estimates of United States-China Bilateral Trade Balances: 1995–2002,’’ Asian Economic Journal, Vol. 14, May/June 2003, pp. 489–496. Note: The official 2002 U.S. data on exports and imports of services are not yet available. We make the assumption that the values of export and import service trade between the United States and China are the

same in 2002 as in 2001.

Table 2.—U.S. Balance of Trade

(Billions of US$)

2000 2001 2002 2003H1

World ....................................................................... ($487) ($448) ($509) ($268)

China ....................................................................... ($90) ($90) ($111) ($54)

Japan ....................................................................... ($85) ($72) ($73) ($32)

Hong Kong .............................................................. $3 $4 $3 $2

South Korea ............................................................ ($14) ($14) ($14) ($5)

Taiwan ..................................................................... ($15) ($15) ($14) ($7)

Table 3.—Chinese Balance of Trade

(Billions of US$)

2000 2001 2002 2003H1

World ....................................................................... $43 $23 $30 $3

United States .......................................................... $30 $28 $43 $23

Japan ....................................................................... $0 $2 $6 ($7)

Hong Kong .............................................................. $35 $37 $26 $27

South Korea ............................................................ ($12) ($11) ($11)

Taiwan ..................................................................... ($12) ($36) ($18)

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1 In 2000–2002, China’s governmental agencies went through a massive review process aimed

at determining which of China’s regulations were WTO-compliant. In May 2002 China’s Ministry of Foreign Trade and Economic Cooperation (now part of the Ministry of Commerce) announced that more than 2,300 laws and regulations had been amended to comply with WTO

rules, and 830 additional laws and regulations had been abolished. 2For example, the WTO mandates the promulgation of regulations on direct selling services

by December 11, 2003. 3The Commission ably summarized these requirements in its 2002 Annual Report (p. 47).

PREPARED STATEMENT OF MARGARET M. PEARSON

SEPTEMBER 24, 2003

Mr. Chairman, Mr. Co-Chairman, and Members of the Commission:

Thank you for the opportunity to testify before you today. I am a Professor in the

Department of Government and Politics at the University of Maryland. I have been

researching and teaching on China’s politics and economy since the mid-1980s, first

at Dartmouth College and now at the University of Maryland. One of my areas of

expertise is China’s participation in the World Trade Organization (WTO).

In my testimony today I wish to address two issues related to China’s rule of law

development, which is of course a core part of the Commission’s mandate. The first

half of my comments addresses the implementation of China’s WTO-related rule-oflaw commitments as they are carried out in domestic legal arena. The second part

of my testimony addresses China’s adherence to international standards in its participation in the WTO in Geneva and related meetings, with particular attention to

the recent WTO Ministerial in Cancun.

I. UNEVEN PROGRESS ON CHINA’S WTO-RELATED RULE OF LAW COMMITMENTS

On the first topic—domestic rule of law commitments—I will focus my attention

on two subjects: promulgation of rules required by China’s WTO accession documents, and development of mechanisms and norms of transparency. I give some attention to where we are in ‘‘year 2’’ of China’s membership, but remain cognizant

that the real and enduring processes the Commission is interested in require we

think with a longer-term metric in mind.

My basic assessment, which I believe is consistent with that of many scholars and

practitioners who follow legal developments as they relate to WTO, is that the

trends in these areas have not changed much since the Commission issued its Annual Report for 2002. It remains the case that over the past decade China has made

great strides in strengthening many aspects of its legal system, including as this

system applies to WTO compliance. Despite substantial progress, however, there is

no question that China has a long way to go toward fulfilling its commitment on

rule-of-law related issues. Its ability to do so routinely will depend on continued evolution of the overall move toward rule of law in the legal system as a whole.

With regard to the promulgation of rules required by China’s accession, as has

frequently been noted, the Chinese government has established or revised many

laws committed to in its WTO accession agreement.1 Still, we continue to await promulgation of many rules for specific industries. Even where broad laws have been

promulgated, detailed implementing rules on market access for foreign firms have

not appeared. For example, in year 2 (by December 11) China’s WTO accession

agreement mandates that several sets of regulations on services be promulgated,

but it is not clear that they will be ready.2 More generally, the pace of law-making

and revising has slowed substantially compared to 2 years ago. This slowing is in

part because much already has been done, but it also reflects the fact that more

difficult and controversial areas are being approached. As time passes, moreover, domestic economic constituencies have mobilized themselves, often in the form of industry associations, and have erected protectionist barriers. Furthermore, new rules

that erect new trade barriers, such as on genetically modified organisms (GMOs)

and other sanitary and phytosanitary concerns, are being issued. Not all will be

judged WTO non-compliant, but some certainly will.

The issue of transparency has received significant attention from the Commission.

China’s WTO commitments speak explicitly to the issue of transparency by requiring that all regulations related to its WTO commitments be published promptly and

in official accessible venues, and that prior to promulgation they be published in

draft form and subject to public comment (including by foreign interests).3 In this

realm of administrative law and procedure, the Chinese government has made

progress in encouraging that laws are published, transparent, promulgated only

after some public comment period, and so forth. Prompt publication of formally

issued laws has proceeded especially well; one hears of fewer and fewer instances

where foreign businesses are told of an internal (neibu) regulation or administrative

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4One recent example that has received much attention is that when China revised its auto

policy regulations it did not issue the drafts publicly or provide foreign companies an opportunity to comment. 5The catalog was posted on the Ministry of Information Industry web site with an effective

date 2 weeks following release and no vehicle for soliciting comment. This catalog is crucial because it classifies telecommunications services into basic services and value-added services, a

distinction of great importance to foreign firms because, for example, the former category is

much more protected than the latter. 6This has been reported with regard to draft laws on retail, franchise and direct selling. See

US-China Business Council, ‘‘China’s WTO-Implementation: A Mid-Year Assessment’’ (US-China

Business Council, 2003). 7This is not to say that much can be done to build capacity in important areas—notably in

the areas of judicial review and enforcement of regulations. 8The most pertinent example is the combination of the Ministry of Foreign Trade and

Economic Relations (MOFTEC), which has lead responsibility for many aspects of WTO implementation, with the State Economic and Trade Commission (SETC) into a new Ministry of Commerce. 9On the importance of incorporating China’s WTO obligations in domestic law to be fully

authoritative, see Donald C. Clarke, ‘‘China’s Legal System and the WTO: Prospects for Compliance,’’ Global Studies Law Review, 2003. 10On independent judicial review of WTO-related administrative actions, I refer the Commissioners to the study by Veron Mei-Ying Hung, ‘‘China’s WTO Commitment on Independent Judicircular that they must abide by yet may not see. There continue to be more instances where drafts have been circulated for public comment with sufficient (if still

short) time to receive comment. Some regulatory agencies—notably the China Securities Regulatory Commission—seem quite committed to these procedures.

Nevertheless, many of the same gaps the Commission found in its 2002 Annual

Report remain. In particular, the adherence to the public comment commitment is

uneven.4 Too often, binding rules that significantly affect market access are issued

without opportunity for comment, as occurred this year with the 2003 Telecommunications Service Classification Catalog.5 Draft rules continue to circulate without a

mechanism for formal comment.6 Sometimes drafts are circulated only among a few

companies (foreign or domestic), often just those former government monopolies

with close ties to the regulator. Public comment periods, even when offered to a

broad range of Chinese and foreign companies, are often too short. Many observers

had also hoped that the WTO-based requirements for transparency also would help

open the policy formulating process to greater scrutiny, though this is not mandated

by WTO. There continues to be disappointment on this front as well.

China has committed to these transparency norms and to the promulgation regulations that enshrine the principles of market access and national treatment. Difficulty in adhering to these commitments cannot be excused. But the difficulties can

be explained. To what, then, can we attribute this continued slow implementation?

At this point, substantial education of officials—funded by the Chinese government

and foreign public and private sources—has been completed. It is no longer compelling to attribute the gaps to a lack of understanding.7 Several explanations are more

compelling at this juncture. First, there continue to be poor coordination mechanisms between the myriad agencies that often must be involved in the promulgation

of any new rules. Indeed, while there is often a lead agency for drafting, another

agency or set of agencies may do the issuing of the rule. Poor ability to coordinate

internally can easily spill out to poor coordination on the external comment requirements. Bureaucracies may shy away from public comment and prior notice, even

though they are not required to do anything with the comments, because they complicate the internal negotiations and bureaucratic wrangling that accompanies the

promulgation of many new rules.

A second structural obstacle to implementation of rule of law obligations is the

ongoing administrative reorganization. I refer not merely to the immediate past reorganization following the National People’s Congress in March 2003,8 but more

generally the longer term establishment of new regulatory agencies and re-division

of authority between existing ministries, bureaus, etc. The administrative lines of

authority remain unclear and poorly institutionalized, and continue to make the

rulemaking process quite contentious.

Finally, the norm of transparency, though gaining ground domestically, is not yet

reflexive. Not until the norm is fully grounded in domestic law will it to become an

entrenched part of the domestic legal and administrative landscape. The promulgation of an Administrative Procedure Law, now in draft form, is expected to lay out

detailed procedures that administrative units must follow, including procedures to

enhance transparency.9 A similar slow process appears to be underway with regard

to establishment of independent judicial review of WTO-related administrative

actions.10

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cial Review: An Opportunity for Political Reform,’’ Working Paper Number 32 (Washington D.C.:

Carnegie Endowment for International Peace, November 2002). Hung discusses the moves made

toward establishing independent judicial review by basing it on the Administrative Litigation

Law, but also notes the political constraints in achieving such independent review that can only

be solved in the longer term and as a result of broader political reforms. 11Margaret M. Pearson, ‘‘China’s Track Record in the Global Economy,’’ in China Business

Review, 27:1 (January-February, 2000): 48–53. 12 A classic statement of this metric is Abram Chayes and Antonia Handler Chayes (1993), ‘‘On Compliance,’’ International Organization, Vol. 47, Issue 2 (Spring), pp. 175–205. 13 A longer version of this analysis, for the period up to June 2003, is Margaret M. Pearson, ‘‘China’s Multiple Personalities in the WTO,’’ in New Trends in the Study of Chinese Foreign

Policy, edited by Alastair Iain Johnston and Robert Ross (manuscript pending review).

Thus, while it is still possible to point in year 2 to progress in the rule-of-law

domain, the unevenness that has been present throughout the compliance process

remains. The continuing unevenness, deadline missing, and so forth, is generating

greater anxiety and disappointment in the foreign community than it was a year

ago, as it appears that these problems are in danger of becoming a permanent part

of the implementation process and not merely a reflection of first-year missteps or

even leadership transition and SARS. Goodwill is dissipating among many foreign

observers and business interests.

Amidst this frustration, it is worth repeating that deep and enduring progress on

many of the rule of law issues of concern to the Commission—not just as regards

China’s WTO compliance, but also more broadly reform of legal procedures and processes, improvement in transparency, establishment of an independent judiciary, and

so forth—are, and will continue to be, driven foremost by internal processes. By

internal processes I refer primarily to the development of domestic constituencies,

either within or outside of the government, with an interest in seeing deep rule of

law oriented reforms. Such reforms can be encouraged and fostered by WTO compliance efforts, but except insofar as they support the development of domestic constituencies, they will contribute primarily at the margins. I am optimistic that there

will be improvement over the medium term on these issues, but as a result of

domestic trends that both pre-dated and go much deeper than China’s WTO implementation.

II. CHINA’S ADHERENCE TO INTERNATIONAL STANDARDS IN THE WTO PROCESS IN

GENEVA

The second issue I wish to address brings a different perspective to rule of law

issues than has been addressed previously in this forum. This perspective examines

China’s activity in WTO in Geneva and at related international meetings, including

the WTO Ministerial in Cancun 2 weeks ago.

Prior to China’s becoming a member of the WTO, the question was often raised

in Washington and elsewhere as to whether China would become a ‘‘revisionist’’ power in the WTO, attempting to change the rules and challenge the norms by

which it operated. At that time, I argued that based on China’s behavior in other

multilateral economic institutions, China was unlikely to be a revisionist power but,

rather, would in most cases ‘‘play by the rules.’’ 11 Now that China has been a member for nearly 2 years, it is useful to evaluate its actual behavior in Geneva.

Prior to engaging in an assessment, however, it is important highlight a distinction

about the use of the term ‘‘cooperation’’ as applied to China’s WTO behavior. We

must be careful not to conflate the notion of ‘‘cooperative behavior’’ with ‘‘adherence

to the agenda of the United States.’’ We may strongly prefer that China’s agenda

in the Doha Round decisions are aligned with those of the U.S. Government. But

cooperative behavior in the WTO must be measured in terms of whether a country

abides by the rules and norms established by the organization as a whole. In other

words, does China adhere to the ‘‘rules about rules’’ of the organization? 12 It is useful to keep in mind, for example, that some of the closest political allies of the

United States may pursue agendas in some areas of the WTO that are quite inconsistent with our own. Hence, a huge number of disputes brought to the Dispute Resolution Mechanism in Geneva involving the United States also involve many close

political and trading partners. At the level of day-to-day negotiations, then, ‘‘co- operation’’ cannot be defined by an absence of conflict with other nations, since conflict over trade interests is assumed and built into the process. Moreover, coalitions

shift from issue to issue.

In the PRC’s first year of membership in WTO, we can conclude that it did not

pursue a revisionist agenda.13 There are two major exceptions, discussed below, that

cut at core issues of Chinese sovereignty. Yet the answer to whether China has been

a ‘‘cooperative’’ power in the WTO is, by and large, ‘‘yes.’’ The Chinese delegation

has made no effort to change the conservative consensus rules of the WTO. The inVerDate 11-MAY-2000 10:53 Dec 19, 2003 Jkt 000000 PO 00000 Frm 00159 Fmt 6601 Sfmt 6621 90833.TXT China1 PsN: China1
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14 All members are subject to a periodic ‘‘Trade Policy Review ‘‘ (TPR) of their trading practices, a review that takes place within the Secretariat office. Reviews of China are not only more

frequent than for other governments (compared for example to biannually for the U.S. and EU)

but also involve multiple functional councils. This ‘‘WTO-plus’’ commitment was established as

a response to the fact that China was to be admitted prior to its full compliance with the terms

of membership set for it. See Paragraph 18 of the accession protocol.

formal processes to which the consensus rules give life are also accepted, notably

the norm of non-interference in issues where a country’s core interests are not involved. (In this, China’s behavior can be contrasted with that of India.) China has

welcomed the expectation of other countries, including the United States, that it

should be—must be—an active participant in major WTO decisions, whether made

formally or informally. China has made several moves to help give developing countries more voice, but except in the case of the meetings earlier this month in

Cancun, these moves have not been particularly disruptive. And in all these moves

China has been much more a follower than a leader.

China for the most part has not made its presence strongly felt in Geneva, moreover. The PRC delegation has spent considerable energy coming up to speed on the

rules and norms of the organization, as well as on the TRM process, as discussed

below. The delegation remains small and understaffed, and thus lacks capacity to

pursue an aggressive agenda across. Moreover, domestic consultative arrangements

have not been established to allow for the formulation of a cohesive trade policy,

further hindering the ability to act aggressively within the WTO.

Despite this overall pattern of cooperation, there are two issues on which China

can be judged as conflicting fundamentally with WTO rules, norms, and expectations: Taiwan’s membership, and the TRM. These issues are perceived in China as

impinging on the PRC definition of a sovereign concern, and as a result China treats

them in more rigidly category.

Taiwan became a WTO member just following China’s accession. The PRC’s treatment of Taiwan’s membership echoes its behavior in other multilateral institutions,

although it is perhaps in some ways less rigid. At times members of the PRC delegation have been willing to meet informally with their Taiwanese counterparts (as in

APEC, for example), and has dealt with the Taiwanese delegation in formal settings

(such as responding to questions from Taiwan in the TRM context. More routinely,

though, the PRC has broken the WTO norms for dealing with other members, notably using Chinese in communications rather than one of the official languages of the

WTO, insisting on meeting in hotels rather than in the Geneva organization’s buildings, and frequently refusing or canceling scheduled consultations on trade issues.

The PRC delegation also has conflicted with the Taiwanese delegation with regard

to issues of nomenclature and the status of the Taiwan mission. The effort is to ensure that reference to Taiwan’s membership in the WTO not imply sovereignty for

Taiwan. Most recently, in the spring of 2003, the WTO Director-General Supachai

Panitchpakdi approached the head of the Taiwan delegation and, in essence, requested Taiwan to accept a downgrading of its status from ‘‘permanent mission’’ to

‘‘office of permanent representative,’’ and to affirm that the actions regarding WTO

representation of Taiwan have no implications for sovereignty. The PRC appears to

have been working through the lead agents of the WTO in an attempt to lend legitimacy to its pressure.

The Transitional Review Mechanism (TRM) is a process established in China’s

accession protocol (and is unique to China) to review annually China’s progress in

implementation for the first 8 years of membership.14 The TRM is enormously unpopular in China. It is a focus point for PRC concerns about national humiliation

and sovereignty, all the more aggravating because Chinese leaders agreed to submit

to it. It also is evocative of the annual most favored Nation status debate in the

U.S. Congress during the decade prior to China’s WTO admission. However, unlike

the MFN debate, China has a direct role in the TRM process and is therefore positioned to be much more defiant.

It was in this context that the first TRM review occurred a year ago, in the fall

of 2002. Under pressure particularly from the United States, discussion of problems

with PRC compliance was initiated several months prior to the formal review scheduled to take place in December. The PRC’s formal response was threefold: compliance issues should not be brought up significantly before the formal date of the

review; China would respond to the issues raised, but only to the letter of the law

and as such would only provide oral answers; and other discussions about compliance should take place in informal and/or bilateral settings. The debate was acrimonious. As China resisted giving full answers it became subject to much criticism.

This left a bitter taste in the mouths of many in the foreign trade bureaucracy. It

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15The WTO’s Fifth Ministerial Conference was held September 9–14, 2003, in Cancun Mexico.

The major substantive item on the agenda was decision on the framework for modalities for agriculture negotiations in the Doha Round. The working draft to be considered as the basis negotiations was the text submitted by the General Council chairman, Uruguay Ambassador Carlos

Perez del Castillo. This draft was seen by the G22 as too close to the draft the United States

and EU had agreed to several weeks earlier, and ignored concerns raised in a draft paper submitted in response by the group in August. 16 China agreed in its accession agreement to reduce average tariffs on agricultural imports

to 15 percent by January 2004, to domestic supports of no greater than 8.5 percent, and a reduction of export subsidies to zero upon WTO entry. These agreements are summarized in Nicholas

Lardy, Integrating China Into the World Economy (Brookings Press: 2002). 17Statements given at the September 8, 2003 media event are reported in Martin Khor,

‘‘Developing Countries Prepare for Agricultural Battle at Cancun Ministerial,’’ TWN Report,

September 9, 2003. The number of countries in the coalition changed over the course of the

meetings from 20, to 21, to 22—hence the differing monikers (G20, G21, and G22).

is likely that the PRC will explore ways to minimize the impact of the TRM in the

current and coming years. I will come back to this point subsequently.

With the exception of these two sovereignty-regarding situations, though, the

PRC’s behavior in Geneva cannot be judged to be revisionist or uncooperative. Indeed, U.S. officials were hopeful for cooperation on a range of issues. With regard

to one major issue on the Doha agenda, agriculture, Chinese trade officials had expressed publicly and privately that cooperation with the US was quite possible on

the proposal Ambassador Zoellick and Secretary Veneman put forward last year.

It was thus contrary to expectation that China might join what is now known as

the Group of 22 developing countries in putting forth a counterproposal to that of

the EU and the United States at China’s first ministerial meeting in Cancun earlier

this month.15 In large part as a result of the stalemate between the two blocs, the

meetings failed to produce an agreement on modalities for further agricultural negotiations. The main complaint of developing countries was that the working draft did

not go far enough to commit to cuts in agricultural subsidies by developing countries, while at the same time asking for tariff reductions by (and with only a modicum of ‘‘special and differential treatment’’ for) developing countries. Developed

countries have argued that the developing countries cannot expect the developed

countries to make all the compromises, and that a breakdown in negotiations does

not further the agenda of the developing countries, which need progress on agricultural negotiations more than the wealthier agricultural nations.

While the internal PRC dynamic leading up to China’s participation in the coalition is not yet fully clear, greater clarity can be shed on what occurred from the

PRC point of view. China, which agreed in its own WTO accession agreement to

lower tariffs, subsidies and supports than virtually any other country, is in the process of defining its own agricultural trade interests.16 The Chinese government is

pinning increasing hopes on agricultural exports—primarily to its Asian neighbors

that maintain high agricultural tariffs—to help ease rural poverty and unemployment. In this, it shares interests with the United States and Cairns Group, as well

as a number of developing countries (but not India). It also has an interest in leveling the playing field in subsidies, which it claims it cannot afford. Its concrete interests therefore are split between a developing and developed country agenda.

How, then, should we assess China’s membership in the Group of 22? First, China’s willingness to join with developing countries on this issue is an important

stand, and does lend weight to the developing agenda. Previous efforts to solidify

a development agenda in agriculture did not get far, and China’s entry into the fray

is certainly part of the reason for the greater hearing to the development agenda

in WTO. Having said that, China’s role in this coalition was to lend support, but

not to lead it or attempt, in rhetoric, to make the discussion more vituperative. The

initiative for the coalition lay clearly with Brazil and India, notwithstanding the fact

that China’s name appeared routinely in articles on the coalition. Indeed, it has appeared quite aloof. China’s delegation to Cancun, led by Minister of Commerce Lu

Fuyuan, did not seek headlines. Lu’s comments to the media conference where the

G22 made its major statements were much more conciliatory than those of other

participants, saying China ‘‘hoped the Ministers would consider the G22 text even

as they are considering the Chairman’s draft’’ (emphasis added). In contrast, for example, the Argentinean Minister said the paper ‘‘must’’ be accorded the same basis

as the chair’s text, while the Brazilian Foreign Minister stated that it was essential

that the group’s paper be taken as a basis for negotiations.17 As discussions among

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18Peter Wonacott and Neil King, ‘‘China Moves Quietly to Push Trade Goals: Beijing, Balancing Needs to Its Farmers, Factories, Treads Softly at WTO Talks,’’ Wall Street Journal, September 15, 2003. 19See for example reports appearing at: www.people.com.cn/GB/jingji/1037/2085439.html;

www.chinanews.com.cn/n/2003–09–12/26/345847.html; www.chinanews.com.cn/n/2003–09–04/26/

342800.html; www.china.org.cn/chinese/EC-c/401659.htm; www.china.org.cn/chinese/2003/Sep/

403738.htm; finance.sina.com.cn/g/20030917/0753448722.shtml; PRC to Support Future WTO

Talks; Promote Interests of Developing, New Member Nations,’’ Xinhua (English), Sunday, September 14, 2003.

ministers were becoming particularly fractious, moreover, Lu intervened to point out

that stalemate (which of course eventually occurred) was in nobody’s interest.18

Moreover, China’s media has barely reported the activities of China in the G22.

The reports that have appeared have been descriptive and factual. No major analysis of the coalition and China’s concrete role in Cancun has appeared in the press.

No effort is being made to undermine the legitimacy of WTO processes, or to promote the idea that China is a developing country and working against the interests

of the United States and EU.19 The key message is that China hopes to play a cooperative role in moving negotiations along in the future.

China therefore has positioned itself, as in past statements in the WTO, to serve as a ‘‘bridge’’ between the developing and developed country agenda. Such behavior

has more than a diplomatic function; it also allows China to maneuver in the future

within the complex agenda, not having burned any bridges, to best meet its evolving

view of its agricultural trade interests. Its doors are still open to diplomacy from

all sides. In other words, it allows the government maximum flexibility in its ability

to form coalitions. This is quite consistent with China’s behavior across a range of

multilateral institutions. In addition, there is a bilateral function to be served. Despite substantial bilateral tensions with India, both countries are trying to move

ahead with international cooperation. Brazil and China, too, have made efforts to

shore up their relationship in recent years. China’s responsiveness to their initiatives is likely to have played a part in the PRC receptiveness to the coalition. Moreover, as China faces another TRM round in the fall, it can perhaps leverage its

support for the cause of the developing world into support for its own efforts to

shape the TRM process.

Returning to the fundamental question of this portion of my testimony, while China’s behavior was inconsistent with the position the United States took at Cancun,

its actions were well within the scope of legitimate actions in the WTO—they did

not breach dominant accepted norms. China’s position reflects the complexity of the

situation and its own evolving interests. Rather than closing the door to cooperation

with any side, it remains open to conciliation.

PREPARED STATEMENT OF YASHENG HUANG

SEPTEMBER 24, 2003

Thank you for giving me this opportunity to testify about an immensely important

and complicated issue in the Sino-US relations as well as in the transition of China

to a market-based economy.

The topic of the hearing is, ‘‘Is China playing by the rules? Free trade, fair trade,

and WTO implementation.’’ In my testimony, I will not address the question whether China is playing ‘‘fair’’ as I believe that fairness is an intrinsically subjective and

political perspective. The first question in the fairness question is fairness to whom.

If you hold the view that the cheap Chinese imports are ‘‘unfair’’ to those US firms

producing the same products, one can equally argue that these imports are ‘‘fair’’

to those Americans who purchase these products. There are also American corporations which purchase imported intermediate products to manufacture their products.

By this logic, those consumers who purchase America-made products that use imported intermediate products from China also benefit from cheap Chinese imports.

As much as I can, I will stay away from this so-called ‘‘fairness’’ question because

I respectfully submit that this question itself is poorly defined. What I want to do

here is to provide an analytical perspective based on facts and evidence rather than

getting into a more complicated issue as to whether China’s trade and investment

practices are fair or not. I am also testifying here in my capacity as a business

school professor who analyzes business and economic trends in China rather than

as a lawyer who follows the detailed legal and regulatory issues involved in the

WTO implementation. What I want to do here is to provide some general backgrounds relating to the role of foreign direct investment (FDI) and foreign trade in

the Chinese economy. My argument is that assessing China’s accession and impleVerDate 11-MAY-2000 10:53 Dec 19, 2003 Jkt 000000 PO 00000 Frm 00162 Fmt 6601 Sfmt 6621 90833.TXT China1 PsN: China1
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1 I have made this argument in greater detail elsewhere. See (Huang 2003).

2 Using the purchasing power parity conversion would yield a lower ratio, but the purchasing

power parity measures are plagued by the uncertainty of exactly what constitutes the right purchasing power parity rate. If the ‘‘true’’ trade/GDP ratio is half of the ratio based on the official

exchange rate, 20 percent of the GDP in foreign trade is still quite large. In comparison, the

same ratio for Japan in 1998 was about 20 percent and for the United States, it was 23 percent

for 1994.

mentation of WTO against this general economic background can yield a very different conclusion from assessing China’s WTO implementation against the specific

provisions in China’s accession document. I believe that China’s WTO implementation should not be judged on narrowly legal grounds but on the broader economic

and social grounds.

There are three general points I want to make and emphasize in my testimony.

First, China acceded to the WTO terms not as a closed economy but as a substantially open economy. In fact, by some measures, China is more open to FDI and foreign trade than the United States. This is a remarkable fact and we need to keep

this in mind when we judge China’s implementation record. Even if China were to

have failed to implement each single provision of the WTO accession document, we

cannot draw the conclusion that this is a closed economy designed to keep out foreigners. My second point is that while we can debate whether cheap Chinese imports are fair to Americans, we can legitimately make an argument that some of

the Chinese regulations and practices are in fact unfair to the Chinese themselves,

especially to the domestic private entrepreneurs, and the largest beneficiaries of unfair treatments are foreign firms; some are American firms.

The third point is that the fact that China appears to be quite open to foreign

trade and FDI is in part a result of some fundamental inefficiencies of its economic

system. These inefficiencies suppress the investment and market potentials of truly

domestic private firms, which are the most efficient firms in the Chinese economy.

The effect of this suppression is that foreign firms have found more business space

in China because they do not compete with the most efficient domestic private firms

to the extent possible. An implication of this way of looking at the roles of foreign

trade and FDI is that as some of these inefficiencies are being alleviated in the long

run—5 to 10 years—the importance of foreign trade and FDI may very well decline

in the Chinese economy.1

Let me organize my comments into three sections. The first section provides evidence to show that Chinese economy, even before the WTO accession, was already

quite open and in fact, by some measures, more open to foreign trade and FDI than

the United States. The second section explains this ‘‘foreign’’ bias in the Chinese

economy—in favor of foreign firms and often to the detriment of domestic private

firms. The third section provides some concluding remarks.

THE UNUSUAL OPENNESS OF THE CHINESE ECONOMY

By a number of conventional measures, China’s economy in fact is quite open

without the benefit of the WTO membership. On the trade side, a large portion of

China’s GDP is accounted for by foreign trade. Using official exchange rate conversion would yield a trade/GDP ratio of 40 percent, an extremely large share for a

continental economy of China’s size.2 For the US, the foreign trade/GDP was around

20 percent in the 1990s. Japan had a similar ratio.

China is also quite open to foreign direct investment (FDI). Since the early 1990s

China has been one of the largest FDI recipients in the world. In 1994, for example,

China alone accounted for 49 percent of the total FDI flows to developing countries

and 15 percent of the worldwide FDI flows. This ratio has declined in more recent

years but China no doubt is the largest recipient of FDI among developing countries. For 2003, according to a number of estimates, China will surpass the United

States in terms of the absolute level of FDI.

Not only is the absolute size of FDI large, its relative size—measured by FDI/capital formation ratio—surpassed that of many countries in the world (discussed

below). I will also provide evidence to show that foreign-invested enterprises

(FIEs)—i.e., joint ventures between Chinese and foreign firms or wholly owned foreign subsidiaries—have established a sizable presence in the Chinese economy and,

in a number of industries, have come to command a dominant position.

FOREIGN VIS-A`-VIS INTERNAL TRADE

The outsized roles of foreign trade and FDI in Chinese economy are not only striking in comparing China with other countries but also in comparing China’s dependency on external trade and on FDI with its patterns of internal, cross-provincial

160

3 (World Bank 1994).

4The finding was reported in (McCallum 1995), as quoted in (Ghemawat 2000).

trade and investments. In a 1994 report, the World Bank—the best study to date—

noted that inter-provincial trade normalized by provincial GDP was smaller than

intra-European trade.3 Transportation costs explain some of this but during the

reform era inter-provincial trade has declined while there have been massive investments in roads, railways and airport facilities. This is a startling fact. Trade economists have long noticed a home bias in trade patterns, i.e., domestic residents tend

to buy from each other much more than they do from foreigners. A study on the

inter-provincial trade in Canada reveals that its internal trade about 20 times its

trade with the 30 states in the United States—the states Canadian provinces traded

with most intensively.4 Canada and the United States are two very similar countries on economic, political, and linguistic dimensions that should facilitate trade between them and yet internal trade in Canada still exceeds external trade by a wide

margin.

FDI/CAPITAL FORMATION RATIO

A good relevant measure of China’s openness to FDI is not the absolute size of

FDI but FDI normalized by the size of the host economy. Countries vary in their

economic and market size and the size of FDI flows ought to be gauged relative to

the size of the host economy. The absolute size of FDI flows for the United States

in 1990 was much larger than the Chinese FDI but the US economy is roughly

seven times as large (on the basis of official foreign exchange conversion). In that

sense, the United States is less ‘‘dependent’’ on FDI than China is even though the

absolute size of FDI flows into the United States is much greater.

A common measure of the relative size of FDI is the ‘‘FDI/capital formation ratio,’’

given by the amount of FDI inflows in 1 year divided by the total fixed asset investments made by foreign and domestic firms in the same year. (In the paragraphs

below, I use the term, FDI dependency, to refer to this ratio.)

Table 1.—Measures of capital inflows: Foreign loans, actual foreign direct investment (FDI), and

contractual alliances, 1979–1999

Amount (US$100 million) Percentage shares of total capital inflowsActual FDI inflows as

a percentage share of

fixed asset investments (percent)2

Total Foreign

loans

Actual FDI

inflows

Contractual alliances1

Foreign

loans

Actual FDI

inflows

Contractual alliances1Of Fixedasset investments

by all

firms

Of Fixed

asset investments

by nonstate

firms

1979–1982 124.57 106.90 11.66 6.01 85.82 9.36 4.82

1983 19.81 10.65 6.36 2.80 53.76 32.10 14.13 0.88 2.63

1984 27.05 12.86 12.58 1.61 47.54 46.51 5.95 1.60 4.52

1985 46.45 26.88 16.61 2.96 57.87 35.76 6.37 1.92 5.65

1986 72.57 50.14 18.74 3.69 69.09 25.82 5.08 2.07 6.21

1987 84.52 58.05 23.14 3.33 68.68 27.38 3.94 2.27 6.41

1988 102.27 64.87 31.94 5.46 63.43 31.23 5.34 2.50 6.86

1989 100.59 62.86 33.92 3.81 62.49 33.72 3.79 2.90 7.97

1990 102.89 65.34 34.87 2.68 63.50 33.89 2.60 3.69 10.90

1991 115.55 68.88 43.66 3.01 59.61 37.78 2.60 4.15 12.36

1992 192.03 79.11 110.07 2.85 41.20 57.32 1.48 7.51 23.52

1993 389.60 111.89 275.15 2.56 28.72 70.62 0.66 12.13 30.81

1994 432.13 92.67 337.67 1.79 21.44 78.14 0.41 17.08 39.18

1995 481.33 103.27 375.21 2.85 21.46 77.95 0.59 15.65 34.35

1996 548.04 126.69 417.26 4.09 23.12 76.14 0.75 15.10 31.81

1997 587.51 120.21 452.57 14.73 20.46 77.03 2.51 15.04 31.66

1998 579.36 110.00 454.63 14.72 18.99 78.47 2.54 13.25 28.27

1999 526.60 102.12 403.19 15.18 19.40 76.60 2.88 11.20 24.10

2000 594.50 100.00 407.10 17.71 16.80 68.50 2.98 10.30 20.60

2001 496.80 468.80 18.40 94.40 3.70 10.50 19.50

2002 550.10 527.40 21.30 95.90 3.87 10.10

Source: State Statistical Bureau, China Foreign Economic Statistical Yearbook 2000 (Beijing, China Statistics Press, 2000). Statistics for

2000, 2001 and 2002 are from http://www.moftec.gov.cn/moftec—cn/tjsj/wztj/wztj—menu.html and EIU.

161

Notes:

1 Contractual alliances refer to asset leasing, compensation trade, and product processing.

2 Fixed asset investments refer to purchases of new plants, property, and equipment made by both domestic and foreign firms in a given

year. All the figures include investments made by FIEs.

Column (3) of Table 1 presents three different measures of the relative FDI size

during three periods in the 1980s, 1990s and the 2001–2002 period. The three periods represent different phases of continuous FDI liberalization, as briefly summarized in the table. Column (3a) uses the fixed asset investments undertaken by all

firms, including foreign firms, as the denominator. Column (3b) includes only the

fixed asset investments by nonstate firms, that is, collective firms, FIEs, and domestic private firms. Column (3c) includes the fixed asset investments made by private

firms and FIEs. One noticeable trend is the sharp rise in the FDI/capital formation

ratio beginning in 1992. When we use the fixed asset investments undertaken by

all firms, including FIEs, the ratio rose from 4.2 percent in 1991 to 7.5 percent in

1992. In 1994, the ratio reached 17.1 percent. Column (3b) shows a more rapid increase in the FDI/capital formation ratio when FDI is normalized by investments

made by nonstate firms.

State-owned enterprises (SOEs) account for a large portion of fixed asset investments. Since the investment activities of SOEs are heavily influenced by the government, it is more appropriate to compare the level of investment activities of foreign

firms with that of nonstate domestic firms. Nonstate firms, including FIEs, are more

market-driven and are subject to harder budget constraints compared with the

SOEs. As the Hungarian economist Janos Kornai points out, SOEs are afflicted with

an ‘‘investment hunger’’ and are prone to over-investing regardless of the market

demand for their products (Kornai 1980). Thus, it is more meaningful analytically

to compare the investment behavior of FIEs with other nonstate firms. Between

1993 and 1997, FDI accounted for over 30 percent of the fixed asset investments

made by nonstate firms in each year and during the same period, on average, FDI

accounted for about 53 percent of the fixed asset investments made by domestic private firms and FIEs. There is no question that FDI is a significant source of investment financing in China.

Table 2 presents data on FDI/capital formation ratios in China and a number of

other countries to provide a comparative perspective. The data are broken down by

three periods, 1986–91, 1992–98, and 1999–2000. China’s FDI dependency varied

during these three periods. Compared with other countries in the table, it was initially low in the first period; it rose to a very high level in the second period; and

it began to decline to a moderately high level in the third period.

Table 2.—Relative FDI Size, Macroeconomic Developments, and Business Environment, Various

Years

Countries

Annual average FDI flows/gross fixed capital formation,

all firms ratios (nonstate fixed asset investments only),

percent

Gross domestic

savings

rate,

1994–97

(percent)

Current

account

balance/

GDP,

1994–97

(percent)

Business environment for

foreign investors

1986–91 1992–98 1999–2000

Rank

in

terms

of ease

of foreign

acquisitions,

1996

(out of

46

countries)

Business

environment

rank,

1996–

2000

(out of

60

countries)

Corruption

perception

rank,

1997

(out of

52

countries)

China .......................... 2.9 (8.6) 13.1 (27.9) 10.6 (21.5) 41.8 2.7 41 44 41

Philippines .................. 6.6 (8.1) 8.3 (10.2) 7.6 (9.4) 15.5 ¥8.5 40 35 40

Indonesia .................... 2.3 (3.4) 5.4 (8.9) ¥13.7 (¥22.7) 33.5 0.0 37 46 46

Thailand ..................... 5.5 (6.5) 5.6 (7.2) 11.9 (17.6) 38.0 ¥6.3 42 30 39

Malaysia ..................... 14.7 (22.8) 16.9 (24.3) 22.1 (30.3) 40.0 ¥0.8 43 24 32

Taiwan ........................ 3.6 (4.3) 2.2 (2.7) 11.8 (14.2) 125.6 1¥2.7 39 21 31

Korea .......................... 1.3 (1.6) 1.2 (2.0) 8.1 (10.7) 35.7 ¥1.8 46 29 34

Singapore ................... 37.6 (49.7) 22.9 (30.3) 24.2 (32) 50.9 16.4 30 6 9

Brazil .......................... 1.6 (2.1) 7.7 (9.0) 27.6 (33.9) 20.1 ¥0.8 29 38 36

Mexico ......................... 8.3 (10.9) 13.5 (17.1) 10.7 (15.6) 21.4 0.5 28 34 47

India ........................... 0.3 (0.5) 2.2 (3.4) 2.1 (2.5) 21.2 ¥2.6 35 45 45

United States ............. 6.5 (7.7) 6.9 (8.1) 15.8 (18.3) 15.6 ¥1.6 19 1 16

Canada ....................... 5.3 (6.1) 9.3 (10.6) 33.6 (38.6) 20.4 1.7 32 5 5

United Kingdom .......... 13.6 (16.3) 13.5 (15.6) 41.9 (54.7) 14.7 ¥0.9 10 4 14

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5 (Urata 2001) presents the FDI inflow/GDP ratios for nine Asian economies (China, Hong

Kong, Korea, Taiwan, Indonesia, Malaysia, Philippines, Singapore, and Thailand) between 1986

and 1997. From 1986 to 1991, China ranked between No. 4 and No. 7 among these nine economies. From 1992 to 1997, China consistently ranked either as No. 2 or No. 3 most dependent

on FDI, behind Singapore and, sometimes, Malaysia. Take 1995 as an example. In that year,

China’s FDI/GDP ratio was 5.1 percent, compared to 2.2 percent for Indonesia, 2.0 percent for

Philippines, and 1.2 percent for Thailand. (It was 4.8 percent for Malaysia and 8.5 percent for

Singapore.) The choice of 1995 was not arbitrary. Because FDI flows can fluctuate more than

GDP, I chose a medium ratio for China rather than either the highest or the lowest ratio. In

1993 and 1994, China’s FDI/GDP ratio was high, at 6.4 percent and 6.2 percent, respectively,

compared to 4.9 percent in 1997. The year 1997 probably should not be used as well because

the Asian financial crisis might have adversely affected FDI flows into the Southeast Asian

countries. The FDI/GDP ratios are from (Urata 2001). 6 As is well known, purchasing power parity (PPP) exchange rates can vary from official exchange rates by a wide margin and, depending on which exchange rates are adopted, the FDI

dependency ratios will differ dramatically. An additional source of complications is that extremely different purchasing power parity exchange rates exist. Even when a purchasing power

parity rate on the high end is used, as in World Development Report 1996, China is still more

dependent on FDI than many other countries, albeit at a smaller magnitude of difference. The

FDI/PPP-based GNP ratio in 1994 was 0.78 percent for Asia as a whole and 0.81 percent for

the industrial countries. At the same time, it was 1.13 percent for China, thus making China

about as dependent on FDI as Canada (1.25 percent), France (1.46 percent), Australia (1.46 percent), and Portugal (1.07 percent). It was more dependent on FDI than the United States (0.69

Table 2.—Relative FDI Size, Macroeconomic Developments, and Business Environment, Various

Years—Continued

Countries

Annual average FDI flows/gross fixed capital formation,

all firms ratios (nonstate fixed asset investments only),

percent

Gross domestic

savings

rate,

1994–97 (percent)

Current

account

balance/

GDP,

1994–97 (percent)

Business environment for foreign investors

1986–91 1992–98 1999–2000

Rank

in

terms

of ease

of foreign

acquisitions,

1996

(out of

46

countries)

Business

environment

rank,

1996– 2000

(out of

60

countries)

Corruption

perception

rank,

1997

(out of

52

countries)

Russia ........................ 2.0 (2.2) 9.1 (10.5) 27.7 4.3 45 53 49

Poland ........................ 0.01 (0.6) 13.1 (16.0) 20.6 (23.7) 16.7 ¥1.7 31 31 29

Note: 1 1994 only.

Sources: FDI data are from United Nations Conference on Trade and Development (1998), United Nations Conference on Trade and Development (1999), United Nations Conference on Trade and Development (2000), and United Nations Conference on Trade and Development (2001).

Private investment , savings and resource balance data are from the World Bank, World Development Report, various years and World Bank

(1995a). For Taiwan, the source is Asian Development Bank (1995). The measure of ease of foreign acquisitions is based on a survey conducted by the International Institute for Management Development in Switzerland. Respondents were asked to rate countries according to a

10-point scale. A perfect score, 10, is given to countries that do not impose any restrictions on foreign acquisitions and 0 is given to countries where foreigners may not acquire control. The data are reported in International Institute for Management Development (1996). The business environment rank is a broader measure devised by the Economist Intelligence Unit. The country ranks for the 1996–2000 period are reported in ‘‘Business Environment Scores and Ranks’’ (2001). The corruption perception rank is devised by Transparency International; the 1997

data are reported on http://www.gwdg.de/?uwvw, accessed on October 23, 2001.

Between 1992 and 1998, on average, FDI flows into China accounted for about

13 percent of the gross capital formation of all firms annually. This ratio is one of

the highest among the countries in the table, even compared with countries traditionally considered to be very FDI-dependent, such as countries in Southeast Asia.

As pointed out earlier, even though the United States attracted a greater amount

of FDI, the relative importance of FDI in the United States, at 6.9 percent during

the 1992–98 period, was far smaller than it was in China. Compared with other

Asian economies, China was less dependent on FDI in the 1980s, but its FDI

dependency was among the highest in the region in the 1990s. China’s FDI/capital

formation ratio during the 1992–98 period was lower than that in Singapore and

Malaysia, but much higher than that in Indonesia, Thailand, and the Philippines.

The standard wisdom is that China is more similar to the Southeast Asian countries

than it is to Korea, Taiwan, and Japan in terms of FDI dependency. That is true,

but in fact China was among the most highly FDI-dependent economies in Asia during much of the 1990s. This is also the case if one uses gross domestic product

(GDP), not fixed asset investment, to normalize FDI inflows.5 (China’s FDI/GDP

ratio is high whether one uses the official exchange rate or the purchasing power

parity rate.6) The claim that China is highly dependent on FDI does not at all hinge

163

percent), Japan (0.03 percent), Italy (0.21 percent), and the United Kingdom (0.98 percent).

These data are reported in (Li and Lian 1999). 7Other researchers have also noted China’s high FDI dependency. Francoise Lemoine (2000),

in a detailed descriptive analysis of China’s FDI, makes the following remark, ‘‘FDI capital stock

represented 25 percent of China’s GDP in 1998, a ratio almost comparable to that existing in

smaller economies which were opened to international capital flows long before China . . .’’ Lemoine points out that on a per capita basis, China’s FDI inflows appear to be low, compared to other Asian countries. In 1998, FDI stock per capita in China was only $160. This measure

is highly questionable. On a per capita basis, China is low on many other fronts. To illustrate

this point, by this measure, the war-torn Angola would be considered more attractive than

China as an FDI host. In 1999, FDI stock per capita in that country was $537. 8 It is likely that the huge mergers and acquisitions in the ‘‘new economy’’ sector of the advanced countries contributed to this rise in FDI dependency and that the financial crises in

Korea, Brazil, and Thailand induced an increase in the type of FDI seeking opportunities related

to financial distress in those economies. In Korea, for example, much of the FDI since 1998 went

into the troubled financial industry. See (Huang and O’Neil-Massaro 2002). Of course, the financial crisis did not induce FDI in those countries where the crisis impaired political stability and

economic growth prospects, as witnessed by the net outflow in Indonesia. 9Guangdong’s investment figure is calculated from Table 2.6, (World Bank 1994, p. 52).

on benchmarking China against traditionally small recipients of FDI, such as Japan

and Korea.7

China’s FDI dependency, in a comparative perspective, is all the more striking if

one takes into account the substantial investment roles of SOEs in China. As already pointed out, SOEs—subject to softer budget constraints compared to nonstate

firms—are prone to over-invest. It is reasonable to expect a country with substantial

public sector investments to have a lower FDI/capital formation ratio. For this reason, China’s high FDI/capital formation ratio—inclusive of investments by SOEs—

compared with other countries with a far smaller public sector is powerful evidence

of the substantial role of FDI in the Chinese economy. Another way to illustrate the

same point is to derive a FDI/capital formation ratio net of investments by public

sector entities. This is indicated by the bracketed numbers in column (1b) of Table

2. By this measure, China’s FDI dependency was the second highest among all the

countries represented in the table. During the 1992–98 period China’s FDI/capital

formation ratio net of public sector investments was 27.9 percent, after Singapore

(30.3 percent) but higher than Malaysia (24.3 percent).

In the 1999–2000 period, that is, column (1c) of Table 1.2, China’s FDI dependency declined compared with many countries in the table. A major factor was the

rapid and sudden surge in FDI dependency among the advanced developed countries, such as the United States, the United Kingdom, and Canada, and developing

countries, such as Brazil, Korea, and Thailand. It should be stressed that this

sudden rise in FDI dependency constituted a substantial deviation from earlier dependency levels in these countries, suggesting that a number of country- and periodspecific developments may have contributed to this outcome.8

What is also interesting is that since China’s WTO accession, in 2001 and 2002,

FDI has continued to decline as a source of investment financing for the Chinese

economy. FDI/capital formation ratio was 10.5 percent in 2001 and 10.1 percent in

2002. This echoes the argument that I laid out at the very beginning of this statement, i.e., a very important reason for China’s unusual openness to foreign trade

and FDI is in fact a result of substantial inefficiencies of China’s economic system.

WTO accord and other policy measures implemented by the Chinese government

since the late 1990s have alleviated some of these inefficiencies and therefore have

actually reduced China’s dependency on FDI. My own view is that in the long run

the role of FDI is only going to decline in the Chinese economy as internal allocation

of financial resources continues to improve.

FDI VIS-A`-VIS CROSS-PROVINCIAL INVESTMENTS

I pointed out before that the Chinese trade with each other less than they trade

with foreigners. There is also a similar investment dynamic here. Some Chinese

provinces depend on FDI to a far greater extent than they do on each other as a

source of investment funds. Take Guangdong province as an example. In 1992,

Guangdong invested about 2.5 percent of its total investments in other provinces

while other provinces’ investments amounted to 1.7 percent of total investments in

Guangdong. In the same year, FDI accounted for 31.7 percent of Guangdong’s investments, far surpassing both Guangdong’s export of capital to other regions and

its import of capital from other regions.9 In monetary terms, the 2.5 percent of outward investments in other provinces amounted to 399 million dollars. To put this

number in perspective, in 1993, firms based in tiny Macao—known more for its casinos than its computers and for its gangs than for its garment making—invested

164

10To clarify, China bans FDI in casinos and thus Macao’s large investment position cannot

be attributed to this source of its competitive advantage. 11See (Zhang Shengman 1999), p. 181. 12The data on India, Chile, and Argentina are provided in (United Nations Conference on

Trade and Development 1998), Annex Table B.3. 13There are 16 provinces that are classified as interior or western provinces. No FDI data

are available for two of these provinces—Inner Mongolia and Tibet. The remaining 14 provinces

are: Shanxi, Anhui, Jiangxi, Henan, Hubei, Hunan, Sichuan, Guizhou, Yunnan, Shaanxi, Gansu,

Qinghai, Ningxia, and Xinjiang. The figures are calculated on the basis of data provided in

(State Statistical Bureau 1996). 14These figures are from (United Nations Conference on Trade and Development 2000), Annex

Table B. 5.

586.5 million dollars in China.10 (Unfortunately, the more recent data on cross-provincial investments are not available. The consensus is that internal trade and investments increased somewhat in the late 1990s but still they are at a lower level

compared with China’s foreign trade and FDI.)

This outsized investment position held by foreign firms is by no means limited

to Guangdong, a province which has wooed foreign investments particularly aggressively. Sichuan, an interior province traditionally isolated from the outside world,

also depended more heavily on FDI than on investments from other provinces. In

1993, investments from other provinces came to represent 0.22 percent of Sichuan’s

total investments; foreign investments, however, represented 5.4 percent. The data

compiled by the World Bank show that out of six provinces four on average relied

more heavily on FDI than on investments from other provinces between 1985 and

1993. This is remarkable and it shows the outsized foreign investor position in the

Chinese economy.

The geographic dispersion of FDI is something that many people do not understand, including Chinese officials and Western economists. For example, in a presentation at a National Bureau of Economic Research conference, Zhang Shengman,

a Chinese Ministry of Finance official and a managing director at the World Bank,

argued that China ‘‘must strive for a more desirable distribution of capital flows,

both geographically (more to the interior) and sectorally (more to some service sectors, retailing, banking, insurance, etc.).’’ 11 Two researchers, Edward Graham and

Erika Wada, in a study on FDI in China make the following observation, ‘‘[V]ast

areas of China, including ones where much state-owned industry is located, have

not been touched by FDI’’ (Graham and Wada 2001, p. 5). In recent years, the Chinese government has made FDI promotion a prominent component of its development strategy for the central and western provinces.

The data that are often cited to support the geographic concentration hypothesis

is that Eastern China accounted for 84.5 percent of cumulative FDI between 1985

and 1991 and 87.3 percent between 1992 and 1998 (Gipouloux 2000). The problem

with this view is that it relies on statistics on the percentage shares of FDI distributed among Chinese provinces. Recall, however, that during the 1990s China attracted an enormous amount of FDI and thus a small portion of FDI going to the

interior provinces is still a significant number. According to statistics provided in

Gipouloux’s study, the interior regions of China accounted for about 13 percent of

cumulative FDI inflows between 1992 and 1998. During this period cumulative FDI

flows into China as a whole amounted to $242.3 billion. This means that the interior

regions of China received $31.5 billion in FDI. To put this number in perspective,

India’s entire FDI inward stock, as of 1997, was only $11.2 billion. In addition, the

poor, hinterland provinces of China absorbed either more than or about the same

level of FDI as some of the star economies in Latin America in the 1990s. As of

1997, the FDI inward stock for Argentina was $36 billion and it was $25.1 billion

for Chile.12

In 1995, the average FDI/capital formation ratio for 14 interior and western provinces was 4.9 percent; if investments by SOEs are excluded, the ratio was 14.9 percent.13 The 4.9 percent figure puts these provinces above Taiwan (2.2 percent),

Korea (1.2 percent), India (2.2 percent), and Russia (2.0 percent). (All the numbers

refer to the 1992–98 period.) The 14.9 percent figure, that is, FDI normalized by

investments of nonstate firms, would make China’s interior and land-locked provinces No. 6 out of the 15 economies represented in Table 2 (excluding China). While

she argues that the FDI distribution pattern in China is uneven, in her own paper,

Lemoine (2000, p. 30) shows that FDI stock/GDP ratio for interior provinces was

10.9 percent in 1998. To put this number in perspective, in 1998, the FDI stock/

GDP ratio for North America was 10.5 percent, for Central and Eastern Europe,

12.9 percent, and for South, East and South-East Asia, 10.5 percent.14

165

15This research is summarized in (Moran 1998, p. 23). 16 Central Europe exhibits a familiar pattern of oligopolistic rivalry among foreign investors.

FDI may disturb national oligopolies, although, as Kogut points out, multinational corporations

prevail in industries characterized by oligopoly. See (Kogut 1996). 17These data are calculated on the basis of Table 4.2 and Table 4.3 in (Yeung 1998).) In the

text, I use data from the 1970s because the industrial groupings are most similar to those in

China, thus facilitating a direct comparison. The materialized amount may differ from the approval amount if an investor fails to invest the pledged amount of capital. 18 Export data for 1995 are from (State Statistical Bureau 1996). For some unknown reason,

the Chinese government no longer released disaggregated FIE export data, broken down by economic sector or industry, after 1995. 19The source of data is Third Industrial Census. The firms covered by the Third Industrial

Census are firms with an ‘‘independent accounting system.’’ This raises a number of data issues.

See the appendix to this chapter for a detailed explanation of a number of data issues involved

in using Third Industrial Census. 20 Calculated from data provided in (State Statistical Bureau 2001). 21The export share data for Taiwan come from (Ranis and Schive 1985).

THE UBIQUITOUS PRESENCE OF FOREIGN FIRMS ACROSS CHINESE INDUSTRIES

FIEs, firms established through FDI, can be found in far more industries in than

other countries. Empirical research on FDI has found that a general pattern of industry distribution of FDI is that FDI is concentrated in just a few industries. For

example, in a survey article Newfarmer and March find that over 80 percent of foreign subsidiaries in Mexico and Brazil were in industries with four-firm concentration ratios exceeding 50 percent. Similar concentration patterns of foreign firms

were found in Peru, Chile, Colombia, and Malaysia.15 According to Bruce Kogut,

FDI in Central European countries exhibited a similar pattern. Foreign firms were

found in only a few industries, such as autos, consumer products, and telecommunications. And the investing firms were familiar ones, such as ABB, Coca-Cola, and

Proctor & Gamble.16

FDI patterns in China are quite different in that FDI is present rather evenly

across different industries. Data are available for FDI from Hong Kong broken down

by industries for the 1990s for a number of countries on a consistent basis. These

data show substantially less concentration patterns in China. For example, in Malaysia, the top three industries with the most Hong Kong FDI accounted for 58.9

percent of the total materialized Hong Kong FDI in 1994. In the same year, on an

approval basis, the top three industries in Indonesia with the most Hong Kong FDI

accounted for 77.6 percent of the total Hong Kong FDI.17 But in China, the top

three industries, electronics, plastic products, and textiles, only accounted for 46.7

percent of total Hong Kong FDI as of 1993. The lower concentration ratio means

that FDI is also present in many other industries in China. In fact among the 28

manufacturing industries, none received more than 10 percent of total FDI as of the

mid–1990s. The highest share was 9.6 percent in the electronics and telecommunications industry. The textile industry followed, at 8.9 percent.

FOREIGN CONTROLS OF EXPORT MARKETING

It follows naturally that the large FDI inflows would have led to a substantial

role of FIEs in the Chinese economy. This is demonstrated in Table 3. As of 1995,

FIEs controlled over half of China’s manufactured exports, or 51.2 percent. Because

FIEs are restricted in the primary industries and FIEs are not allowed to be pure

trading corporations, their export share of total exports is smaller; in 1995, it was

31.5 percent.18 By 2002, FIEs accounted for over 50 percent of Chinese exports. Nationwide, FIEs dominate the export channels in a number of industries, such as

electronics and telecommunications, garments and footwear, leather products, printing and record pressing, cultural products, and plastics, etc. In 1995, they accounted

for over 60 percent of Chinese exports in these industries.19 Nor are sales shares

insignificant as well. In four industries, the sales shares of industrial FIEs exceeded

50 percent of industry sales and accounted for 21 percent of all manufactured sales

in 1995. This share grew to 32.1 percent by 2000.20

Again, it is easier to illustrate the substantial role of FIEs in the Chinese economy by benchmarking China against other economies. FIEs in China have established a far more dominant position in export production than their counterparts in

Taiwan, when Taiwan was in a comparable stage of development as China in the

1970s. As of the mid-1970s, FIEs in Taiwan accounted for only 20 percent of Taiwan’s manufactured exports.21 The share of FIEs in China’s exports not only exceeds that of Taiwan but of other Asian countries as well during comparable stages

of development. Two authors, Seiji Naya and Eric Ramstetter, provide some of the

most complete statistics. Their paper shows that, except for Singapore, where multinational corporations (MNCs) have traditionally dominated domestic firms, no other

166

22 All the data on Korea and the Southeast Asian countries are from (Naya and Ramstetter

1988). Data for later years are more difficult to find, except for the export production data by

FIEs in Indonesia cited in the text. 23 A good discussion on this topic is found in (United Nations Conference on Trade and Development 1998), especially pp. 209–221.

Southeast Asian country came close to the 51 percent share of manufactured exports

claimed by Chinese FIEs.22 In Korea, between 1974 and 1978, foreign firms accounted for 24.9 percent of manufactured exports. In Thailand, in the 1970s, the

share ranged from 11 to 18 percent, and in 1984 it was 5.8 percent.

Table 3.—Export Shares of FIEs in Total Exports of Three Economies: China, Taiwan, and

Indonesia

(In percent)

China (1995) Taiwan (1980) Indonesia (1995)

Labor-intensive industries Garments and footwear: 60.5 Garments and footwear: 5.7 .. Garments and footwear: 33

Leather and fur products:

73.2.

Leather and fur products: 9.6 Leather and related products:

19.7

Furniture: 75.1 ....................... Lumber and bamboo products: 2.7.Furniture: 14.0

Capital or technology-intensive industries.Electronics and electrical appliances: 83.4.Electronics and electrical appliances: 50.5.Electric, measuring, and photographic apparatus: 78.8

Paper and paper products:

53.4.

Pulp paper and paper products: 4.5.Computers and parts: 91.8

Chemical materials and products: 31.6.Chemicals: 34.9 ..................... Machinery and vehicle parts:

86.1

.......................................... .......................................... Paper and paper products:

29.8

.......................................... .......................................... Chemical materials: 42.3

Manufacturing industries 51.2 ........................................ 20.6 ........................................ 29.0

Sources: Chinese data are from Office of Third Industrial Census (1997) and Taiwanese data are from Ranis and Schive (1985, Table 2.12,

p. 109). Indonesian data are unpublished and were provided to the author by the Indonesian government through the kind assistance of Timothy S. Buehrer and Lou Wells. Professor Lou Wells generously provided English translations of the Indonesian text.

Table 3 presents FIE shares of total exports in three economies, China (1995),

Taiwan (1980), and Indonesia (1995). The table breaks down export data by laborintensive and capital- (or technology-) intensive industries. Two patterns emerge.

One is that the FIE shares of exports in labor-intensive industries are much higher

in China than in Taiwan or Indonesia. For example, garment and footwear FIEs accounted for 60.5 percent of exports in China, but only 5.7 percent in Taiwan and

33 percent in Indonesia. FIEs similarly dominated exports in leather and furniture

in China to a far greater extent than they did in Taiwan and Indonesia. The second

pattern is that in capital- or technology-intensive industries, FIEs in China and Indonesia dominated exports to a far greater extent than they did in Taiwan. This is

a more common pattern in developing countries, not only because the local capabilities in modern industries are low, but because the goods being produced are intermediate inputs, such as electronic components. Japanese firms, for example, have

invested heavily in Southeast Asia to produce electronic components, which are reexported to the parent firms.23 Ownership arrangements are more common for this

type of goods because often the only way for local producers to gain access to the

supply chain of the MNCs is to be part of the MNC system. (In contrast, garments,

footwear, and furniture are final goods or near final goods).

FOREIGN CONTROL OF ASSETS

The significant position of FIEs in the Chinese economy raises a natural question

about control. Corporate control is a complicated concept but the simplest measure

is the investor’s share of the equity ownership. The higher the share, the more control the investor is said to have since equity ownership is usually an indicator of

how decisionmaking power is apportioned among investors, through, for example,

the number of board seats one can appoint. Since many FIEs in China are JVs, decisionmaking is shared among Chinese and foreign investors. The allocation of decisionmaking power is determined on the basis of their respective shares of equity

ownership.

Foreign firms have established majority controls over FIEs in most industries.

Only in 7 out of 28 manufacturing industries are foreign firms found to have an average aggregate minority equity position, that is, the total equity value owned by

167

24Most of the industries, including the more capital-intensive industries, have a large number

of enterprises. For example, there were 1,409 FIEs in the transport equipment sector in 1995.

The high foreign equity share is not the result of large equity positions of a few foreign firms. 25The Taiwanese data are reported in (Ranis and Schive 1985). 26Quoted in (Lubman 1998).

the foreign firms is less than 50 percent of the industry sum of FIE equity.24 Stateowned monopolies or oligopolies are typically found in those industries where

foreign firms have minority stakes. The tobacco industry is probably the most illustrative example. It is run by a single government agency, the China Monopoly

Bureau of Tobacco Industry, which operates integrated production from tobacco procurement to cigarette making. But even in this heavily monopolistic industry, the

combined equity stake of foreign firms already reached 46.9 percent by 1995. While

foreign firms have been able to make inroads into industries explicitly reserved for

the most powerful government corporations, nonstate indigenous firms have been

largely excluded.

Another characteristic is that foreign majority equity controls seem unrelated to

some of the well-known features of these industries. Foreign majority controls span

both labor-intensive industries, such as garments, footwear, and leather products,

and capital-intensive industries, such as chemicals, machinery, and instrument

manufacturing. This across-the-board foreign equity control contrasts with the Taiwanese pattern. In Taiwan foreign firms have dominant equity positions in certain

industries, such as garments and footwear (71.8 percent), lumber and bamboo products (75.7 percent), and leather and fur products (79.6 percent). But in quite a number of industries, they are mere minority investors (such as nonmetallic minerals,

chemicals, and the machinery industry).25 Thus, in China not only do foreign firms

have larger equity positions and thus putatively greater corporate control over FIEs,

their controls are uniform across industries.

WHY CHINESE ECONOMY IS ‘‘UNUSUALLY’’ OPEN?

Chinese economy should be considered ‘‘unusually’’ open in two ways. First, it appears to be more dependent on foreign trade and FDI even compared with many

market-oriented, developed economies. Second, Chinese economy is unusually open

in that some sectors of the Chinese economy are more open to foreign investors than

to domestic private businesses. In fact, one can go further by arguing that precisely

because Chinese economy is quite closed to the domestic private sector it has become more open to foreign investors as a result. I have elaborated on this point in

greater detail in my recently published book, Selling China (New York: Cambridge

University Press, 2003). Let me explain this point here.

CONSTITUTIONAL STATUS: FIES AND DOMESTIC PRIVATE FIRMS

Western investors often view China’s legal system as the single most important

deterrent to FDI inflows. In 1997, a survey conducted by the European Commission

of 200 European companies operating in China stated that ‘‘incomprehensible or unpredictable rules and legislation remain the principal obstacle to investment in

China.’’ Looking forward, foreign investors are not very optimistic about the prospects of rule of law in China. In a 1997 survey on 22 foreign firms active in China,

only 4 of them expected the rule of law to become widely accepted in China while

most of the respondents viewed rule of law to be a goal of the government but not

reality of the Chinese economy and society.26

The usual question in the studies on government regulation is whether the regulatory environment is ‘‘business-friendly.’’ The answer to this question in the Chinese context is easy: It is not. The Wall Street Journal and Heritage Foundation

rated China in 2002 as a ‘‘mostly unfree’’ economy (given a bright yellow color to

join the likes of India, Cambodia, Romania and Bulgaria) even after more than 20

years of remarkable economic reforms. According to the aft-cited study, ‘‘China’s

legal and regulatory structure remains so riddled with contradictory internal (neibu)

unpublished guidelines and exceptions that foreign businesses say progress in the

rule of law has actually slowed in recent years.’’ (The Heritage Foundation and The

Wall Street Journal 2002)

Many of these analyses, while not factually wrong, miss one of the most fundamental features of the Chinese economy. While it is widely recognized that Chinese

legal system functions poorly, the relevant question is whether the Chinese legal

system functions more poorly for some firms than for other firms. In particular, we

want to know whether the legal system consistently favors one type of firms over

others in accordance with the nationality of the firm. Here China is quite unique

168

27For an extensive analysis, see (Gelatt 1983). 28The text of the 1982 Constitution and the 1988 amendment is found in, Constitution of the

People’s Republic of China, (Beijing, Foreign Languages Press, 1994). 29See Anonymous, ‘‘Amendments to the Constitution of the People’s Republic of China,’’ Beijing Review, May 3–9, 1999.

among many countries in that the government has created a legal framework that

is on balance more favorable to foreign firms than to domestic private firms.

On balance, the legal treatment of FIEs has been far superior than that accorded

to domestic private firms (although inferior to that of state owned enterprises or

SOEs). The most remarkable example concerns the constitutional treatment of FIEs

and domestic private firms. China’s Constitution, adopted in 1982, only 6 years after

the Cultural Revolution, clarified and offered protection to the legal status of foreign

enterprises operating in China (Article 18). Foreign enterprises were permitted ‘‘to

invest in China and to enter into various forms of economic cooperation with Chinese enterprises and other Chinese economic organizations . . .’’ 27 Article 18 also

swore to protect their ‘‘lawful rights and interests.’’

While Article 12 of the Constitution prohibited ‘‘appropriation or damaging of

State or collective property,’’ no such a commitment was made about the property

rights of private enterprises. Remarkably, more than 25 years after reforms began,

the Constitutional treatment of domestic private firms remains inferior to that of

foreign firms investing in China. The Chinese State has yet to make a Constitutional commitment not to nationalize or expropriate the assets of domestic private

investors without ‘‘due cause and compensation,’’ the right foreign investors got in

1982.

One example is the low political and legal status of private businesses. Article 11

of the 1982 Constitution acknowledged the property rights of self-employed private

businesses—termed the individual economy—but it did not acknowledge the property rights of other types of private firms. In 1988, Article 11 was amended to add

a clause that the State permitted private firms and that the State was to protect

their ‘‘lawful rights and interests,’’ but the amendment also subordinated the private

sector to ‘‘a complement to the socialist public economy.’’ 28 This meant that private

firms were allowed entry only in industries where they did not pose a competitive

threat to the SOEs, but the strength of property rights protection provided to private businesses lagged far behind that for SOEs and even for FIEs.

In more recent years, the treatment of domestic private businesses began to improve. In March 1999, Article 11 was amended again and the private economy was

to be a ‘‘component’’ of the Chinese economy. This meant, at least nominally, that

private firms, FIEs, and SOEs were to have an equal status. In 2001, the former

president of China, Jiang Zemin, welcomed private entrepreneurs to join the communist party. In 2003, the Chinese officials were discussing a Constitutional amendment—to be adopted in 2004—that would specifically pledge protection of property

rights to private businesses. (For texts of relevant clauses of China’s Constitution,

see Table 5.) 29

Table 5.—Evolving Constitutional provisions regarding private and foreign property rights in

China, 1982–1999

Constitutional

provisions

Adopted at the Fifth Session of the

Fifth National People’s Congress, December 4, 1982

The amendment adopted at the Seventh

National People’s Congress at its First

Session, April 12, 1988

The amendment adopted at the third

session of the Ninth National People’s Congress, March 1999

Article 11 ... ‘‘The individual economy of urban

and rural working people, operating within the limits prescribed by law, is a complement to the socialist public

economy. The State protects

the lawful rights and interests

of the individual economy..

Article 11 of the Constitution

shall include a new paragraph,

which reads: ‘‘The State permits the private sector of the

economy to exist and develop

within the limits prescribed by

law. The private sector of the

economy is a complement to

the socialist public economy..

Article 11 of the Constitution is

amended to: ‘‘The non-public

sector of the economy comprising self-employed and private businesses within the domain stipulated by law is an

important component of the

country’s socialist market economy.

169

30 Institute of Industrial Economics of Chinese Academy of Social Sciences, China’s Industrial

Development 2000, (Beijing: Economic Management Press, 2000). 31The phenomenon of a lending bias on the part of the Chinese banking system in favor of

SOEs was widely documented. See Ronald I. McKinnon, ‘‘Financial growth and macroeconomic

stability in China, 1978–1992: Implications for Russia and other transitional economies,’’ Journal of Comparative Economics, 18, 1994, pp. 438–469, and Nicholas R. Lardy, China’s unfinished economic revolution, (Washington, DC, Brookings Institution, 1998).

Table 5.—Evolving Constitutional provisions regarding private and foreign property rights in

China, 1982–1999—Continued

Constitutional

provisions

Adopted at the Fifth Session of the

Fifth National People’s Congress, December 4, 1982

The amendment adopted at the Seventh

National People’s Congress at its First

Session, April 12, 1988

The amendment adopted at the third

session of the Ninth National People’s

Congress, March 1999

The State guides, assists and supervises the individual economy

by administrative control.’’.

The State protects the lawful

rights and interests of the private sector of the economy,

and exercises guidance, supervision and control over the private sector of the economy.’’.

The State protects the legitimate

rights and interests of the selfemployed and private businesses. The State exercises

guidance, supervision and

management over the self-employed and private businesses.’’

Article 18 ... ‘‘The People’s Republic of China

permits foreign enterprises,

other foreign economic organizations and individual foreigners to invest in China and

to enter into various forms of

economic cooperation with Chinese enterprises and other Chinese economic organizations in

accordance with the law of the

People’s Republic of China..

All foreign enterprises, other foreign economic organizations as

well as Chinese-foreign joint

ventures within Chinese territory shall abide by the law of

the People’s Republic of China.

Their lawful rights and interests are protected by the law

of the People’s Republic of

China.’’.

Source: Constitution of the People’s Republic of China, Beijing, Foreign Languages Press, 1994 and ‘‘Amendments to the Constitution of the

People’s Republic of China,’’ (1999) Beijing Review, May 3–9.

FINANCIAL BIASES

As China’s pace of integration into the world economy accelerated, some influential economists in China argued that domestic private firms were often regarded as

inferior compared to other firms in the Chinese economy. A 2000 report by the Chinese Academy of Social Sciences concluded the following:30

Because of long-standing prejudices and mistaken beliefs, private and individual

enterprises have a lower political status and there are numerous policy and regulatory discrimination and limitations. The legal, policy, and market environment is

unfair and inconsistent.

For a long time, there was a severe lending bias against private firms in favor

of the SOEs.31 Until 1998, the four big state-owned commercial banks, which controlled most of the banking assets, were specifically instructed to lend to SOEs only.

(The Bank of China could lend to FIEs.) Lending to nonstate firms by the four commercial banks remained a minuscule portion of their loan portfolios. Among the

nonstate firms, FIEs were able to access the Chinese banking system more readily

than the domestic private firms. It should be pointed out, however, that the primary

function of China’s banking system is to serve the financial needs of the SOEs.

China’s licensing policy also discriminated against private firms. In 2002, a top

legislator, Tian Jiyun wrote in People’s Daily that over 60 industrial sectors were

open to FDI but only 40 industrial sectors were open to investments by domestic

private firms. Foreign trade licensing was also biased against domestic private

170

32Data are from the State Statistical Bureau, Zhongguo tongji nianjian 2002 [China Statistical Yearbook 2002], (Beijing, Zhongguo tongji chubanshe, 2002).

firms. While the FIEs could directly export and import products within their business lines and many SOEs could export directly, until 1999, most private firms were

required to export through the official state-owned trading corporations.

EFFECTS OF DISCRIMINATION AGAINST DOMESTIC PRIVATE SECTOR

One of the effects of discriminating against domestic private firms while maintaining a relatively open stance toward FDI is that foreign firms have managed to

establish substantial market and industry positions, as documented in the previous

section of this statement. In comparison, truly private firms—defined as those controlled by private entrepreneurs completely independent of the government—were still quite small. Excluding self-employed business units, truly private industrial

firms only accounted for 9.2 percent of the value of the gross industrial output as

of 2001. Industrial FIEs, in contrast, accounted for 28.5 percent.32

A related effect is that the business environment, while admittedly difficult for

many foreign firms in China, is in fact even more difficult for domestic private

firms. We have a subjective measure—the perceptions of foreign and domestic firms

of the constraints of China’s business environment—to illustrate this point.

Our perception data come from the World Business Environment Survey (WBES).

The survey was implemented in 2000 and it focused on perceptions of factors external to the firm. Many dimensions of business environment were surveyed, ranging

from perceptions of the national business environment as shaped by local economic

policy; governance to the perceptions of regulatory, infrastructural and financial impediments and public service quality. The survey was done on roughly 100 firms in

each of some 80 countries. For the first time, China agreed to be a part of this type

of surveys.

Very fortunately, the survey breaks down firms by their foreign and domestic

ownership. Table 6 presents the average response scores given by foreign and domestic firms to a number of questions measuring regulatory burdens, rule of law,

helpfulness of the government, and general business constraints. The minimum

score is 1, indicating a good business environment perception; the maximum score

ranges from 4 to 6, indicating a bad business environment perception. (The survey

includes firms with ownership ties to the government. I have excluded them from

Table 6 in order to demonstrate the contrast between FIEs and domestic private

firms.)

Table 6.—The average response scores given by foreign and domestic private firms on business

environment in China, 2000

Foreign

firms

Domestic

private

firms

Business regulations: 1=no obstacle; 4=major obstacle ...................................................................... 1.79 1.90

Labor regulations: 1=no obstacle; 4=major obstacle ........................................................................... 1.62 1.70

General constraint—taxes and regulations: 1=no obstacle; 4=major obstacle .................................. 1.86 2.17

Confidence in judicial system today: 1=fully agree; 6=fully disagree ................................................. 2.59 2.77

Quality of courts: 1=very good; 6=very bad .......................................................................................... 3.15 2.97

Changes in laws and regulations: 1=completely predictable; 6=completely unpredictable ................ 3.37 3.15

Helpfulness of central government today: 1=Very helpful; 5=Very unhelpful ...................................... 3.00 3.02

Helpfulness of local government today: 1=Very helpful; 5=Very unhelpful .......................................... 2.76 2.62

General constraint—financing: 1=no obstacle; 4=major obstacle ...................................................... 2.93 3.48

General constraint—corruption: 1=no obstacle; 4=major obstacle ..................................................... 1.93 2.13

Source:World Bank Business Environment Survey.

In some areas, domestic private firms feel more constrained than foreign firms;

in other areas they feel less constrained. In general, domestic firms are constrained

in the area of regulations. They gave a higher score for business and labor regulations and on general constraint on taxes and regulations. In general, foreign firms

are less satisfied with China’s legal system than domestic firms, although domestic

firms appear to have less confidence than foreign firms in China’s judicial system.

Foreign and domestic private firms rate government similarly in terms of helpfulness of the government, although domestic private firms view local governments as

more helpful. On the two critical measures of a business environment, financing and

corruption, domestic private firms indicate more constraints than foreign firms and

on the issue of financing constraint, substantially so.

171

CONCLUDING REMARKS

Let me conclude by coming back to a point I made at the very beginning of this

statement. China’s WTO implementation is not a narrowly legal issue but should

be judged against the general economic background of the country. Chinese economy

is in fact ‘‘unusually’’ open to foreign firms not because it has very liberal FDI policies but because it has very illiberal policies toward the domestic private sector. A

thorough WTO implementation may in fact help ease some of the constraints on domestic private sector and thus may contribute to a decline of the role of foreign

trade and FDI in the Chinese economy. In fact, this is already happening since China’s WTO accession as the government is trying to create a more equal playing field

for foreign firms and for domestic private firms.

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PREPARED STATEMENT OF HON. JAMES A. LEACH, A U.S. REPRESENTATIVE IN CONGRESS FROM IOWA, CHAIRMAN, CONGRESSIONAL-EXECUTIVE COMMISSION ON CHINA

SEPTEMBER 24, 2003

This morning the Congressional-Executive Commission on China convenes to examine U.S.-China trade relations in the context of the development of the rule of

law in China. We have asked our distinguished panelists to share their expert views

with us on the Chinese trade policies that have a negative affect on U.S. businesses

and whether or not the Chinese pursuit of such policies can be characterized as ‘‘unfair’’ under international norms and standards.

The Chinese economy has experienced unprecedented growth in recent years. Between June 2002 and June 2003, Chinese exports grew by 32.6 percent. Foreign direct investment into China grew to $52.7 billion in 2002, pushing China past the

United States and for the first time making it the number one target for foreign

investment. While these growth trends began long before China’s entry into the

WTO in December 2001, increased access to the largest consumer market in the

world and sweeping market reforms will only increase China’s attractiveness as a

manufacturing base. Under these circumstances, China’s robust growth may well

continue for many years.

But along with the benefits of WTO membership come responsibilities. The United

States, together with all of China’s trading partners, has been monitoring very carefully China’s compliance with its obligations under the WTO accession protocol. In

June 2002, the Commission held a hearing to look prospectively at China’s ability

to comply with its rule of law-related commitments. At that time, and according to

the assessment of many experts throughout the first year of China’s WTO membership, the consensus was that it was ‘‘too early to tell’’ whether China would be able

to comply, and that China’s performance in the second year after accession—when

China had a chance to demonstrate its efforts to meet its obligations-would tell us

more.

As we near the end of ‘‘Year 2,’’ we ought to look again at how China is faring

as a member of the international trading community. Measuring WTO compliance

is one of the few empirical tools we have to assess the development of the rule of

law in China: China’s commitments to change its laws and policies are legally binding, and they have been embraced by the political leadership. Most trade experts

agree that China has done very well in reducing tariffs, as required by the WTO

terms of accession. Such explicit obligations are easier to meet, and China’s trading

173

partners may determine more easily whether or not China is in compliance with

them.

The WTO obligation to remove non-tariff barriers, however, is much harder to fulfill

and also harder to assess. For example, indirect subsidization of protected industries

may contravene WTO requirements. Also, failure to meet rule of law obligations, including transparency, equal application of the laws, the institution of judicial review, and national treatment for foreign goods and investors, may in effect operate

as non-tariff barriers. Such barriers may unfairly protect domestic industries, and

it may be that the United States should take specific steps to seek to break down

these barriers. We must first, however, seek to understand the nature of these violations, and then we can determine the course the United States should take to seek

redress. We hope today’s testimony will help give us a sense of what the United

States could and should ask China to do.

One potential consequence of WTO noncompliance may be exacerbation of the

U.S.-China bilateral trade deficit. The trade imbalance has become an issue of great

concern to Americans in the past year, especially in communities dependent on

manufacturing for economic survival. Although American concerns about the losses

of the U.S. manufacturing base are legitimate, understanding what the bilateral deficit means and what its root causes are is crucial to finding the solution to the problems caused by the loss of manufacturing jobs. For this reason, we look forward to

hearing testimony on how the United States should approach the U.S.-China trade

imbalance.

Some argue that China’s undervaluation of its currency, the yuan, is a leading

cause of the bilateral imbalance and also may be a violation of the WTO Subsidies

Agreement. Others say that critics overstate the impact of the yuan’s value, and

that China’s currency policy complies with its international obligations. Beyond the

WTO, the Commission is keen to understand whether China’s currency policies, or

any other of its domestic policies, are ‘‘unfair’’ in the sense that they contravene the

standards that China is reasonably expected to uphold as member or the international community and a partner in the international economic system.

We look forward to hearing the views of our witnesses about how well China is

complying with its WTO commitments, and whether China may or may not be

conforming to other international standards and norms that may affect American

businesses and the American economy. We hope all the panelists will recommend

steps that the U.S. Government should take to address the outstanding issues in

U.S.-China trade relations.

PREPARED STATEMENT OF HON. CHUCK HAGEL, A U.S. SENATOR FROM NEBRASKA,

CO-CHAIRMAN, CONGRESSIONAL-EXECUTIVE COMMISSION ON CHINA

SEPTEMBER 24, 2003

The U.S.-China relationship is the most important relationship our country will

have over the next 50 years. Managing this relationship will be as complicated as

it is critical. We must get it right.

China’s economic and political influence is growing, and few problems in the AsiaPacific region can be solved without its cooperation. The United States and China

are finding new ways to cooperate, from achieving stability in Northeast Asia, to

intelligence sharing in the war against terrorism, to joint operations in battling

international trafficking in narcotics. Despite this, we should not be surprised that

we will continue to have serious differences with China. China must improve its

human rights practices. It must improve its proliferation safeguards. And it must

live up to its WTO commitments. Each of these issues, if left unresolved, will impact

our overall relationship.

China’s current trade and economic policies demand close scrutiny because they

impact both U.S. national security policy and U.S. jobs. Trade remains the biggest

common denominator between our two countries and it offers the mutual benefits

necessary to build a stable relationship for the future. However, U.S. exports to

China have failed to keep pace with imports and it is in the best interests of both

countries to adjust this imbalance. This will require China meeting its obligations

for full, effective and uniform application of WTO commitments at the national, provincial, and local levels. China must also develop a reasonable timetable to achieve

full convertibility of the yuan. The question of whether a currency is under or overvalued, and by how much, cannot be settled in the absence of a free market.

China has undertaken many of its obligations under the WTO accession process,

particularly in the area of tariff reductions. However, as the American Chamber of

Commerce in China recently noted in its 2003 White Paper, ‘‘the WTO honeymoon

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period is over.’’ China is failing to implement its own laws protecting intellectual

property rights. It has not taken the concrete regulatory steps necessary to open

specific industries and sectors to competition. Progress on soybeans has been particularly troubling. U.S. exporters have faced Chinese government policies that are

as unclear as they are complicated, and most recently U.S. soybean exports have

been disrupted by non-science-based phytosanitary restrictions. China’s efforts to

meet its WTO commitments to implement tariff rate quotas for bulk agricultural

products have been equally unsatisfactory. China must move forward in meeting

each of these obligations.

China understands that the political stability of Asia is closely linked to an expanding global economy, and this to the continued development of a fair and open

trading system. China and the United States share this important goal. Building

a cooperative agenda will not grow out of unrealistic expectations of what both sides

can achieve in the short term, but instead out of the clear-eyed realization that we

have a mutual interest in developing a common approach to a wide range of bilateral, regional and global issues in this new century. China’s willingness to work

with us in the coming weeks, months, and years will tell us much about whether

China and the United States will move forward in building a deeper and more relevant relationship.

PREPARED STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR FROM MONTANA

SEPTEMBER 24, 2003

Thank you, Chairman Leach and Co-Chairman Hagel, for holding this hearing.

It comes at an important time.

While the United States has lost millions of manufacturing jobs in the last few

years, China’s exports of manufactured products to the United States have soared.

We’re on track for the U.S. trade deficit with China to exceed $100 million for the

second year in a row. In these circumstances, it is not surprising that a rising chorus of voices is demanding that something be done about China.

One thing that we can do is to look carefully to make sure that China is properly

implementing its WTO obligations. We are now approaching the end of the second

year of China’s WTO membership. This provides a good opportunity for us to take

stock of how China is performing as a full member of the world trading system.

It is my own sense that China has come a long way toward implementing the

commitments it made in its WTO accession agreement, but it still has a long way

to go. Problems that could have been chalked up to glitches or ‘‘startup’’ difficulties

in the first year of China’s WTO membership are now, in some cases, being seen

as evidence of a lack of resolve on the part of the Chinese government to meet its

obligations.

TRANSPARENCY IN REGULATIONS

Perhaps chief among these is a widespread lack of transparency in licensing and

permitting regulations, both in their drafting and their application. This makes it

very difficult for U.S. companies to operate in China.

Although China has passed many of the laws required under its WTO commitments, it has in many cases not issued any implementing regulations. This is true

for various sectors of the economy, including the financial services, distribution, and

automotive sectors.

When regulations are issued, they are frequently issued without allowing sufficient time for industry participants to comment. And they often impose barriers,

such as excess capitalization requirements, that appear designed to discourage foreign businesses from entering the market at all.

TARIFF RATE QUOTAS

Another problem of great concern to me deals with China’s failure to allocate its

tariff rate quotas (‘‘TRQs’’) for agricultural products in accordance with its accession

agreement. China has allocated uneconomic amounts to some quota recipients. It

also does not disclose the identity of those receiving allotments as it had agreed to

do. This makes it difficult for U.S. companies to identify potential customers. Further, import permits are effectively being used to maintain import controls on U.S.

agriculture commodities and meat exports, important products for my home State

of Montana.

This is a longstanding problem. In July, I urged USTR to begin preparing a WTO

case on Chinese TRQs. Since then, I have been told that there may have been some

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movement toward a resolution on this issue. I hope the witnesses can inform us

about any progress on China’s TRQs.

INTELLECTUAL PROPERTY

China’s attitude toward intellectual property is also great cause for concern.

Counterfeiting of U.S. trademarks is rampant. Copyright piracy is a thriving industry in China. The piracy rate for movies, video games, and music approaches 90 percent. This is clearly unacceptable. China needs to do more to protect intellectual

property.

I am also concerned about regulations China is currently developing for a government

procurement law China enacted earlier this year. Those regulations would require

the government to purchase only domestic goods and services, including software.

VALUE-ADDED TAX

Another issue deals with China’s value-added tax (’’VAT’’). In some cases, China

applies its VAT to discriminate against imports. Officials may exempt locally produced goods while assessing the full VAT on imported goods, or they may rebate

the VAT on goods made and sold in China.

CURRENCY

The final issue I want to raise deals with China’s currency. China pegs its currency at a fixed exchange rate that economists estimate is undervalued by anywhere

between 15 to 40 percent against the U.S. dollar. This artificially depresses the

prices of Chinese exports and hurts the competitiveness of U.S. manufacturers.

When I was in Cancun a few weeks ago for the WTO ministerial, I had the opportunity to discuss this issue with Chinese Commerce Minister Lu Fuyuan. Minister

Lu made clear that China appreciates the need to revalue its currency for its own

internal reasons, but he added that this won’t happen for several years.

We should continue to impress upon the Chinese the many reasons why it should

allow the value of its currency to be determined according to market principles. As

an interim step, China should immediately revalue its currency significantly or

begin to set its exchange rate values in reference to a basket of foreign currencies—

rather than simply pegging it to the dollar. This is an issue that I will continue to

follow very closely.

CONCLUSION

I’ve chosen to highlight just a few of the problems in China’s WTO compliance

and trade with the United States. There are others.

I hope the witnesses will discuss these issues in their testimony. In particular,

I hope they will address what steps the United States has taken or plans to take

to respond to these concerns.

I worked hard to ensure China’s accession to the WTO, and I will work hard to

ensure that China abides by its WTO commitments. I look forward to working with

my colleagues and the Administration to make sure that China plays by the rules.

Thank you.

PREPARED STATEMENT OF HON. MARCY KAPTUR, A U.S. REPRESENTATIVE IN

CONGRESS FROM OHIO

SEPTEMBER 24, 2003

Mr. Chairman, I am pleased that the Commission is meeting today to discuss our

trade relations with China. As an original member of this Commission, I believe it

is vital that we look at the record trade deficits we have with our number one trading partner.

First, as I examine the list of panelists, I must express some concern about its

makeup. There is plenty of representation for the Administration, Big Business, and

academia. Unfortunately, one of the most essential voices has been silenced—that

of the workers. There is no representation of the working men and women from the

United States or China. We hardly can understand the full spectrum of issues related to trade relations without hearing from the people on the factory floor or those

who work in the fields. To ignore this is inexcusable.

The Commission should ensure that we always start with the facts. One of the

most noteworthy details is our escalating trade deficit with China. Mr. Chairman,

I ask that the following be inserted into the record:

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China Trade Deficit

(In billions)

1999 (Before PNTR) ................................................................................................................ ¥$68

2000 (PNTR passed in May) .................................................................................................. ¥83

2001 .......................................................................................................................................... ¥83

22002 ........................................................................................................................................ ¥103

2003 (Through May) ............................................................................................................... ¥65

When I began my career in Congress, the discussion was much the same—only

we were speaking about Japan. Record trade deficits, questions about currency valuation and market access were the hot topics. Little has changed 21 years later. Several administrations and legislative proposals later, little has changed because

Japan is not a free market. It is a managed market. We have tried to open the Japanese market. In 1983, less than 3 percent of Japan’s market consisted of automobiles or auto parts from international sources. In 2003, it is the same. It does

not matter if it is 150 yen to the dollar or 98.

What makes us think that China is any different? It too is a managed market.

The only way we will be able to measure success is through the trade deficit. Are

we buying more or selling more?

Over the last decade, the U.S. has lost millions of manufacturing jobs. Fifty cents

of every U.S. farm dollar comes from Federal subsidies. Something is fundamentally

wrong with the trade accounts and it is evident at the highest policy levels. The

United States is essentially cashing out its wealth.

One such wealth is the job of the working American. I call on the various departments who are supposed to be overseeing our trade policy—United States Office of

the Trade Representative, Department of Commerce, and the Department of

Labor—to invest some of their resources in workers here and in China. Let us as

a Commission, as Members of Congress, travel to China to see what is really going

on.In my area of the country, Huffy Bicycle had 2,000 people employed in Ohio manufacturing the best bicycles in America. All of those workers have now lost their

jobs. They were earning a living wage. They had health benefits. They produced a

fine product.

Those Huffy bicycles are now made in China. This Commission should visit that

factory. The Administration should travel with us to see the working conditions. Instead of a living wage they earn starvation wages. I cannot imagine the type of

‘‘health plan’’ with which the Chinese workers were presented.

The expatriate companies are trading on the exploitation of workers. They are

trading on environmental conditions where they are leaving cesspools around the

earth. Until we challenge that, the U.S. will never balance these trade accounts. It

is well-known that these imbalances are not sustainable. We need to be realistic

and, in turn, create a realistic trade plan.

I encourage the USTR and the Departments of Commerce and Labor to set a target of reducing our trade deficit. I am not going to suggest that we turn a deficit

into a surplus overnight. However, we must stem this tide of record trade deficits.

Simply working toward a lower level this year than last would be a step in the right

direction. This is not an unattainable task. It is one upon which our economic future

depends and the least the Administration could do for working families.

PREPARED STATEMENT OF HON. SANDER M. LEVIN, A U.S. REPRESENTATIVE IN

CONGRESS FROM MICHIGAN

SEPTEMBER 24, 2003

Today’s hearing is called, ‘‘Is China Playing by the Rules? ’’ The answer to that

question is clearly and unfortunately, ‘‘No.’’ China has not yet come into full compliance with its WTO commitments. I am not talking about the commitments that China’s WTO agreement allows it to phase in; I am speaking of the commitments China

agreed to fully implement either immediately or within its first 2 years of WTO

accession. China has not yet fulfilled many of these commitments; in other cases,

China has taken steps that indicate a clear intention to undermine its WTO market

access commitments.

In many areas, China has made substantial progress and it is important to acknowledge that progress. At the same time, halting progress is not what the U.S.

bargained so hard for. The United States is fully living up to its WTO commitments

vis-a`-vis China—evidenced by total Chinese imports to the United States of $125

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billion. The massive trade deficit with China of over $100 billion—the single largest

U.S. bilateral trade deficit—reminds us that we cannot be satisfied with mere ‘‘progress’’ from China. We need complete, unconditional, and timely compliance

from China with its WTO commitments.

Last year, many in Congress, the business community and the Administration

were willing to take a ‘‘pressure and patience’’ approach, giving China time to make

all the myriad changes to law and practice necessitated by WTO accession. Indeed,

we still must realize the massive restructuring that China’s legal system, even Chi- na’s society, is undergoing by virtue of China’s membership in the WTO. Had China

made concerted, uninterrupted, and steady progress toward WTO compliance, that

approach may have continued.

Unfortunately, the Chinese government’s lack of attention to the rule of law has

infected its approach to WTO compliance. The Chinese government has often taken

arbitrary and inconsistent approaches to its WTO obligations; it has acted in nontransparent ways and refused to publish the laws and regulations with which businesses must comply; in some cases, the Chinese government has retained for itself

a large measure of discretion, creating an uncertain environment and leaving companies unclear as to what the rules are.

Moreover, China has blocked effective use of the specially negotiated annual Transitional Review Mechanism (TRM) of China’s WTO compliance. In most cases, China

has refused to provide written answers to questions submitted by other WTO Members; in many other cases China has refused to provide any answers or given vague

and evasive answers. China has denied consensus on efforts to make the TRM process more effective and has even gone so far as to call countries that raised concerns

about China’s WTO compliance ‘‘troublemakers,’’ reminiscent of language China

uses in the domestic context to silence dissent.

Listed below are just some of the continuing problems with China’s WTO accession:

• Transparency.—Article X of the WTO requires countries to publish in advance all

laws, regulations, etc. affecting the import, sale, distribution, transportation, insurance, warehousing, inspection, etc. of imports. China has made some progress,

but still does not uniformly publish laws and regulations applicable to trade,

meaning U.S. firms often do not know what the rules are, whether the rules have

changed, or how to comply with the rules. • Additionally, even when China does publish regulations, these are often very

vague and leave government authorities wide discretion, which is applied in an

unpredictable manner and in ways preferential to Chinese-based manufacturers. • Quota Administration and Import Licensing.—China’s administration of its quotas

and import licensing rules has made it very difficult for companies in China to

import products from the United States and for U.S. exporters to find Chinese

buyers. For instance, China announced increases in quotas on automobiles and

auto parts, but there is little public information on what companies received quota

allocations or how those quotas may be exercised. In some cases, allegations have

arisen that China has awarded import quotas in economically unviable amounts,

to domestic producers of competing products or state-owned companies that have

no intention of importing, and to companies that have committed to use the import only as an input for products to exported. • Discriminatory taxes.—China continues to impose discriminatory taxing schemes

on various ‘‘border trade’’ products and other products, including integrated circuit

products. The former clearly violates MFN and the latter clearly violates China’s national treatment obligations. • Continuing Limits on Trading Rights.—China only allows some companies to import and export products (‘‘trading rights’’). China strictly controls which companies have such rights, and uses this control as a tool to restrict imports. China

agreed to broaden trading rights, but it has not yet implemented its commitments

and appears to be imposing new conditions on these rights. • Distribution Rights.—Even if U.S. products are imported via trading rights, China

imposes limits on who may distribute products. China uses these distribution

rights as a way of keeping out U.S. imports. China is obligated by its WTO commitments to expand distribution rights, but has failed to take all the steps necessary to do this. • Intellectual Property.—Intellectual property piracy is rampant throughout China.

China has made progress to improve its legal framework, but continues to have

a poor record of enforcement, suggesting a lack of will from the government.

• Technical Barriers to Imports.—In some sectors China has issued new technical

product and safety regulations that are sui generis and appear to be designed to

help keep out imports.

• Currency Undervaluation.—Article XV(4) of the GATT prohibits WTO members

from using ‘‘exchange action’’ to ‘‘frustrate the intent of the [GATT] provisions.’’

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China has allowed kept its currency pegged to the dollar at a rate that economists

agree is substantially undervalued, effectively providing a ‘‘currency tariff’’ on

U.S. exports to China and a ‘‘currency subsidy’’ to Chinese imports to the United

States.

• Auto Financing and Other Financial Services Limited by Unreasonably High Capital Requirements.—China agreed to open its auto financing market to U.S. firms

upon its WTO accession. China has not complied with this obligation 2 years

later. Its draft regulations contained unreasonably high capital requirements that

are not justified by any prudential or regulatory rationale and it has yet to issue

final regulations. Other U.S. financial services providers face similar market access barriers.

• Auto Industrial Policy Paper.—In April of this year, China issued a draft ‘‘Development Policy for Auto Industry’’ setting forth Chinese government industrial policy for the automotive industry. This paper is admittedly light on specifics, but

the following concepts in the paper are or could be problematic:

—Mentions ‘‘macroeconomic steering’’ to achieve the objective of becoming ‘‘one

of the major automobile manufacturing countries in the world by 2010.’’

—Indicates numerous points in which the state will standard-less control over

competitive decisions of automobile manufacturers in China through various approval mechanisms, which could be used as way of forcing technology transfer

or limiting allowable imports.

—Includes plans to restrict the number of ports through which imported autos

may enter.

—Requires that imported and domestically produced autos be distributed

through separate sales outlets.

—Sets export targets of components and parts of 40 percent by 2010.

—Suggests that technical requirements will be used as a way of keeping out

imports and simple assembly operations.

—Indicates that the state will provide subsidies for the development of auto

electronics.

—Dangles for foreign firms the possibility of a ‘‘strategic alliance’’ with a domestic firm that would have 10 percent market share in exchange for technology

and know-how transfer.

—Suggests availability of state-subsidized capital for the domestic auto industry.

—Indicates firms will have to produce domestically in China at least 5 years

before they can enter new product lines or open new factories in other cities.

—Indicates that preferential treatment will be given to plants set up for export.

—Indicates that state subsidies will be provided to develop stronger domestic

steel plate for autos manufacturing capacity and machine tools and dies.

—Sets goal that Chinese companies will provide designs for half of all domestically produced cars by 2010.

—Indicates that quotas and creative application of customs duties will be used

to keep out auto part imports.

Compliance with WTO obligations cannot be a one-way street. It is time for the

USTR to take the lead and aggressively demand China’s complete, unconditional,

and timely compliance with all of its WTO commitments. USTR must use every avenue to push China to come into compliance with its WTO obligations. Last year, the

USTR allowed China to block effective use of the TRM, and it looks as if this year,

USTR is resigned to accept continuing uncooperativeness by China as a fact of life.

The TRM was designed to help avoid larger confrontations over China’s WTO compliance. If China continues to defy the WTO and frustrate the TRM process, USTR

should begin a campaign of cases against China in WTO dispute settlement.

American manufacturers are justifiably concerned that Chinese imports have free

access to our market, while China has refused to open its market more fully to U.S.

goods. It is time to start taking concrete action to remedy the imbalance.

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