United States General Accounting Office

GAO Testimony

Before the Committee on Banking and Financial Services,

House of Representatives

For Release on Delivery

Expected at

1:00 p.m., EDT

Monday,

July 29, 1996

INTERNATIONAL TRADE

Challenges and

Opportunities for U.S.

Businesses in China

Statement of JayEtta Z. Hecker, Associate Director,

International Relations and Trade Issues, National

Security and International Affairs Division

G O A

years

1921 - 1996

GAO/T-NSIAD-96-214

Mr. Chairman and Members of the Committee:

I am pleased to be here today to discuss some of the challenges and

opportunities for U.S. businesses in China. My statement is based upon

what we have observed as a result of completed and ongoing work

addressing various issues regarding U.S.-China trade and economic

relations. As you know, after 15 years of economic reform, the Chinese

economy has become one of the fastest-growing in the world. However,

while China has moved toward a quasi-market system, significant trade

barriers still exist, according to U.S. businesses and the office of the U.S.

Trade Representative (USTR). While managing to liberalize its economy and

maintain rapid growth, the Chinese government has not yet fully

implemented fundamental standards for international commerce. Despite

gains that have been made in certain sectors, U.S. businesses still face a

wide array of challenges in obtaining access to the China market. My

statement today will cover

(1) China as a potential market for U.S. businesses, highlighting sectors

where economic expansion will require foreign expertise and equipment;

(2) some of the challenges U.S. businesses face in gaining market access in

China, as well as the concerns of some firms now operating there on

issues such as China’s accession to the World Trade Organization (WTO);

and

(3) World Bank efforts to develop Chinese commercial standards to meet

international norms, with a special focus on the importance of reforming

China’s banking and financial services sector.

The Expanding China

Market

The size and growth rate of China’s economy in recent years has made it a

large export market for the United States. According to World Bank

figures, on a purchasing power parity basis1

 China had the world’s second

largest economy in 1994, with a per capita gross national product (GNP) of

$2,510 and a population of about 1.2 billion people. As China’s economy

has expanded, its demand for U.S. products has also grown. U.S. exports

to China grew by 27 percent, to $11.7 billion in 1995. According to the

Commerce Department, over the last 5 years U.S. exports to China have

increased an average of 20 percent per year. In 1995, U.S. imports from

1

The World Bank defines “purchasing power parity” as the number of units of a country’s currency that

is required to buy the same amounts of goods and services in the domestic market as one dollar would

buy in the United States.

Page 1 GAO/T-NSIAD-96-214
China grew by 17 percent, to $45.6 billion, with a resulting trade deficit of

$33.9 billion.2

In 1995, the top five U.S. imports from China—which accounted for about

65 percent of total imports from China—were (1) miscellaneous

manufactured articles such as toys and games, (2) clothing and apparel,

(3) footwear, (4) telecommunications and sound recording and

reproduction equipment, and (5) electrical machinery. According to a

senior Commerce Department official, China acts as a provider of low-cost

goods to the United States that largely compete with similar products from

India and Indonesia. In 1995, the top five U.S. exports to China—which

accounted for about 45 percent of total exports to China—were

(1) fertilizers, (2) transport equipment (mainly aircraft and aircraft parts),

(3) cereals and cereal preparations, (4) textile fibers, and

(5) telecommunications and sound equipment. According to the U.S.

Department of Agriculture, China is an increasingly important market for

U.S. agriculture exports. In 1995, China purchased nearly 40 percent of all

U.S. fertilizer exports and nearly 10 percent of all wheat and corn exports

sold by U.S. farmers.

Within China, U.S. and foreign businesses continue to rapidly increase

their operations and investments. Between 1992 and 1994, foreign direct

investment (FDI) in China increased from $11.3 billion to $33.8 billion. The

United States is China’s third largest investor, behind Hong Kong and

Macau (combined) and Taiwan, according to Chinese statistics. In 1995,

total FDI in China was $37.5 billion, of which the U.S. share was

$3.1 billion, or 8 percent of the total. According to World Bank figures for

1995,3

 China was the largest developing country recipient of net FDI, with

42 percent of all FDI going to developing countries.

Key Sectors for U.S.

Exports to China

The World Bank estimates China’s expected infrastructure development

expenditures (e.g., transportation, power generation, and

telecommunications) to be $750 billion over the next decade. According to

the Commerce Department, between 1993 and the year 2000 China will

expend $45 billion to $50 billion on transportation, including airport

construction and air traffic safety and control capabilities. Between 1996

2

However, as we reported in International Trade: U.S. Government Policy Issues Affecting U.S.

Business Activities in China (GAO/GGD-94-94, May 4, 1994) the U.S. and Chinese governments disagree

over how bilateral trade statistics should be calculated. The Chinese government records many goods

that it ships through Hong Kong as Chinese exports to Hong Kong, while the United States records

these goods as Chinese exports to the United States.

3

Preliminary 1995 data from the World Bank.

Page 2 GAO/T-NSIAD-96-214
and 2000, China is expected to purchase more than 300 large passenger

aircraft, with a value of $13 billion. Furthermore, China may spend about

$65 billion to expand its energy production. Over the next 10 years,

China’s plans for economic growth call for 168,000 megawatts of

additional generating capacity — more than three times America’s

projected investment. With regard to telecommunications equipment and

technology, the Commerce Department expects China to spend over $10

billion between the years 1993 and 2000. China is expected to add

100 million phone lines to the domestic network, equal to the entire

number of phone lines already installed in the United States. Finally, China

is expected to spend $35 billion on improving its environmental

conditions.

In sectors where U.S. businesses hold a comparative advantage, China’s

plans to develop its infrastructure continue to present opportunities for

U.S. exports. U.S. entry into these sectors remains important because

initial purchases may set the standards for technology, equipment, and

services procurements which, in turn, may encourage future exports.

Impediments to

Accessing the Chinese

Market

Since China initiated its series of market-oriented reforms, it has made

progress in moving toward adopting international trading standards,

including a series of memorandums of understanding (MOU) with the

United States. However, the transition from a nonmarket economy to a

more open, market-oriented economy has been a challenge for both China

and its trading partners. In particular, increased market access,

enforcement of intellectual property rights (IPR) protection, and the

implementation of international trade standards in China have been the

focus of both ongoing negotiations between the United States and China

and of concern by the U.S. business community.

Market Access In October 1992, the United States and China signed a groundbreaking MOU

dealing with market access issues. The MOU commits China, among other

things, to increase the transparency of its trade regime by openly

publishing all trade-related laws, regulations, and decrees; removing a

significant number of nontariff barriers and significantly reducing selected

tariffs; and eliminating standards and testing requirements as barriers to

trade, especially for agricultural products.

Page 3 GAO/T-NSIAD-96-214
In January 1995, we reported on the implementation of the 1992 MOU4

 and

found that while China had taken steps to comply with most of the

provisions of the agreement, U.S. companies continued to experience

market access problems. The most frequent concern reported by the 33

companies we interviewed was in the area of transparency, which refers to

the extent to which laws and regulations are open, clear, measurable, and

verifiable. A majority of those who cited transparency as a problem

reported that China’s trade and investment laws are unclear, inconsistent,

or administered in a seemingly arbitrary manner. Companies also

expressed significant concern over the high level of certain Chinese tariffs,

which price U.S. goods out of the market. Some U.S. companies we

interviewed also reported problems with Chinese nontariff barriers. The

most frequently cited were import-licensing requirements, which in some

cases resulted in increased technology transfer or increased local content

and were perceived as time-consuming and arbitrary.

The 1996 USTR annual report on foreign trade barriers5

 shows that these

issues continue to pose problems for U.S. businesses in China, despite

some progress. The report indicates that the goal of achieving

transparency and uniformity of trade rules throughout China remains

elusive; that China still maintains a large number of nontariff measures

such as quotas and licensing requirements; and that China’s tariffs, in

many cases, remain prohibitively high. The USTR report also highlights

other areas of concern regarding market access. These include the

following:

• China continues to use standards and certification practices that the

United States and other trading partners regard as trade barriers. This has

the effect of adding to the cost of manufactured goods and the outright

banning of certain agricultural products.

• Despite China’s commitment to publish all laws and regulations affecting

imports and exports, some regulations and directives remain unpublished.

Moreover, there is no published, publicly available, national procurement

code in China.

• China’s market for services remains severely restricted. China denies U.S.

and other foreign companies national treatment,6

 and in many service

4

See U.S.-China Trade: Implementation of Agreements on Market Access and Intellectual Property

(GAO/GGD-95-61, Jan. 25, 1995).

5

See 1996 National Trade Estimate Report on Foreign Trade Barriers, USTR (Washington, D.C.: 1996).

6

National treatment is the act of treating a foreign product or supplier no less favorably than domestic

suppliers.

Page 4 GAO/T-NSIAD-96-214
sectors foreign firms are confined to providing services to other foreign

firms or joint ventures.

Intellectual Property In recent years, the United States and China have also struggled over an

area of great importance to the United States: intellectual property. In

January 1992, the United States and China signed the MOU on intellectual

property, resolving USTR’s Special 301 investigation7

 on China’s inadequate

protection of U.S. IPR. China committed to revising its patent law,

providing administrative protection for certain U.S. pharmaceutical and

agricultural chemical product inventions, enacting a law providing

protection for trade secrets, and providing effective procedures and

remedies to prevent or stop IPR infringement. However, as we said in our

January 1995 report, U.S. companies experienced serious problems with

enforcement of China’s new intellectual property regime, particularly with

the absence of a viable enforcement structure, inconsistent application of

laws and regulations, a lack of resources dedicated to IPR enforcement,

and a pervasive lack of transparency. In 1994, USTR again initiated a Special

301 investigation. This led to a new MOU on enforcement in February 1995,

which was designed to address many of the problems found in our report,

particularly the protection of copyrighted works, and trademarks, and

increased market access for products based on intellectual property.

As with the 1992 MOU, problems occurred with the implementation of the

enforcement MOU. The acting USTR recently testified that while China had

taken action to improve intellectual property protection, particularly in the

retail sector, it had not enforced key areas of the 1995 agreement,

including halting IPR piracy at its source. As a result, the United States in

May 1996 announced the publication of a retaliation list targeting Chinese

exports to the United States, which would have matched the approximate

value of damage inflicted on U.S. industries—estimated at $2 billion. In

June 1996, China responded and took action to close over 15 factories

producing pirated compact disks; announced a concentrated enforcement

period targeted at areas where piracy is serious, such as Guangdong; and

took steps to provide protection against the import and export of pirated

intellectual property at China’s borders, among other measures. In

addition, according to USTR, China took steps to further open its market to

U.S. software and audiovisual companies. USTR plans to continue

7

Under what has been commonly called the “Special 301” process of the Omnibus Trade and

Competitiveness Act of 1988 (P.L. 100-418, 19 U.S.C. 2242), USTR performs an annual review to

identify countries that do not provide adequate or effective protection for U.S. intellectual property

rights. If a country is designated a “priority foreign country,” USTR must decide within 30 days

whether to initiate an investigation into the country’s IPR practices.

Page 5 GAO/T-NSIAD-96-214
discussions with China on the need for further progress on IPR

enforcement.

Implementing International

Trade Standards

One important goal for both China and the United States, encompassing

everything from tariffs to intellectual property rights and agriculture, is the

issue of China’s entry into WTO. The United States has consistently held

that it supports the entry of China into WTO on the basis of a commercially

viable package and on terms that are consistent with WTO provisions. To

do so, U.S. officials have developed a “road map” that crystallizes the basic

decisions China must make in each substantive area covered by WTO,

according to recent USTR testimony. The United States and China have

been holding discussions on China’s WTO accession.

Many U.S. businesses operating in China report that, before China enters

WTO, improvements in China’s market access policies are necessary. Based

on our meeting with the American Chamber of Commerce in Beijing and

supported by a February 1996 Chamber survey of its members, U.S.

businesses believe China’s government must make fundamental

improvements, including allowing foreign companies to engage in direct

trade in China (i.e., buying and selling in their own names), reducing

import restrictions, and protecting IPR. In addition, in the survey almost

60 percent of the respondents said they have not seen any significant

liberalization of barriers in the services sector, and almost 75 percent said

that they have had problems with the lack of clarity in investment

regulations.

Finally, several academic China experts we met with described the need

for improvements in the basic infrastructure of Chinese institutions

regardless of entry into WTO, such as China’s legal system and the rule of

law in general; both its assemblies and its judiciary; and the central bank

and the central revenue systems.

World Bank Efforts to

Develop Chinese

Commercial

Standards

As China continues to reform its economy, the World Bank has provided

loans and technical assistance intended to strengthen the domestic private

sector and assist China in meeting international commercial standards.

During the 1990s, China has been the largest recipient of World Bank loan

commitments. Since 1981, the World Bank has committed about

$23 billion in loans and loan guarantees for over 160 projects. According to

the Chief of the World Bank’s resident mission in Beijing, Chinese leader

Deng Xiaoping made China’s membership in the World Bank a priority

Page 6 GAO/T-NSIAD-96-214
after initiating economic reforms in 1978. The Chief of the mission told us

that the Bank was the first foreign financial institution China asked to help

reform its economy. He emphasized that China has directed its own

economic reform agenda and has utilized the Bank’s services as a vehicle

for developing the reform process.

Lending Activities The World Bank has provided funding for various sectors, including

agriculture, transportation, energy, health, education, and the

environment. The Bank’s development efforts have included projects

related to trade, such as port facilities and railways. Of the $23 billion in

Bank funds committed for China, about $8.5 billion have been credits from

the Bank’s International Development Association (IDA). IDA efforts in

China have recently begun to focus on poverty reduction and

environmental activities. The International Finance Corporation, the arm

of the Bank that provides loans and equity to the private sector in

developing countries, has provided about $486 million in loans and equity

for 18 projects in China. The Bank’s Multilateral Investment and Guarantee

Agency has provided investment insurance, valued at about $79 million,

for about 20 projects in China

Bank Activities Intended to

Strengthen Commercial

Standards

Assisting China in implementing market-oriented reforms is a major thrust

of the Bank. According to the Bank’s resident mission Chief, Bank

operations have recently begun to focus on building institutions necessary

for private sector development. For example, the Bank is placing special

emphasis on commercializing the operations of state-owned enterprises

and reforming the financial sector. The Bank’s framework for helping

China reform its state enterprises involves (1) creating autonomous

corporate enterprises; (2) separating the provision of social services (e.g.,

housing, social security, education, and health) from the enterprises;

(3) subjecting the enterprises to market discipline; and (4) diversifying

ownership, for example, by encouraging mergers, consolidations, sales,

and leases. The Bank cites reforms of state-owned enterprises as key to

improving efficiency in the Chinese economy and to facilitating reforms in

the financial sector.

To address financial sector reforms, the Bank is currently financing a

technical assistance loan to help China establish banking policies and

commercial banking practices. Another technical assistance loan focuses

on the preparation of economic legislation, legal training, and

strengthening legal institutions responsible for legislation and

Page 7 GAO/T-NSIAD-96-214
implementation of economic laws. According to China’s Ministry of

Finance officials, the Bank has promoted tariff reform, the shareholding

system, international competitive bidding, and has helped draft 54 laws

that pertain to economic development.

As part of its efforts to promote market-oriented reforms, the Bank is

emphasizing competition in a variety of sectors, such as transportation

and energy. In transportation, the Bank is helping China reduce subsidies.

According to officials in Shanghai’s Municipal Finance Bureau, the

transportation sector is moving from a monopoly to an oligopoly and is

reducing subsidies so that consumers and enterprises share expenses. The

Bank is also supporting China’s efforts to ensure that enterprises in the

power industry are run as efficient businesses and are attempting to

reduce barriers to entry. China has already introduced competition in the

power sector by holding competitive bidding for construction of most new

power plants and allowing independent power producers to compete.

Bank assistance will continue to emphasize the transition of regional or

provincial power companies to autonomous, business-oriented entities.

Chinese government officials told us that benefits from World Bank

financing go beyond lending and have helped improve the way institutions

operate. For example, Chinese government officials told us that the Bank

has helped improve the managerial expertise of government staff by

introducing international competitive bidding practices, project appraisal,

and project evaluation methods. Officials also told us that the Bank has

helped introduce financial analysis techniques and methods for managing

assets and liabilities. Additionally, officials from the Shanghai Municipal

Electric Power Bureau said that under World Bank loans they have sent

managers abroad to gain skills in evaluating the economic, technical, and

financial elements of projects, as well as understanding international

auditing standards and financial management.

Reforming the

Banking and Financial

Services Sector

The Bank is continuing to assist China in further reforms, which

emphasize greater commercialization in banking activities. China is

gradually opening up its financial market to foreign financial institutions,

but still limits the scope of business activities.

World Bank Assessment of

China’s Reform Efforts

According to the World Bank, a primary objective of financial sector

reform in China is to phase out direct controls by the government while

relying increasingly on commercial criteria. Although China has

implemented some reforms, the government’s investment and credit plans

Page 8 GAO/T-NSIAD-96-214
continue to steer most financial resources to state enterprises, making it

difficult to allocate resources efficiently (i.e., to uses that achieve the

highest return within a sound regulatory environment). This situation,

according to the Bank, has resulted in a large share of nonperforming

loans extended by state banks and inefficient operations.

Based on information from the World Bank, China began changing its

banking system as early as 1978. Since 1993, China has made the People’s

Bank of China responsible for monetary policy and supervision of the

financial system, has created three policy banks to separate “policy”

lending from commercial lending, and has granted increased autonomy in

investment lending decisions to state commercial banks. To continue

reforming the financial sector, the World Bank has recommended, among

other things, that China (1) give further autonomy to state commercial

banks by allowing them to design their entire lending program on their

own, (2) facilitate the transformation of state commercial banks into

genuine commercial banks, (3) reform interest rates to reduce the large

number of officially-determined interest rates, and (4) strengthen

regulatory oversight of nonbank financial institutions. Although legislation

authorizes the People’s Bank of China to set monetary policy, China’s

State Council must still approve its decisions, according to the U.S.

Treasury Department.

Other Reforms According to the U.S. Treasury Department, China has taken actions to

increase the participation of foreign financial institutions. For example,

China has gradually expanded the number of cities and special economic

zones in which foreign financial institutions may apply for licenses. After

consultations with the U.S. Treasury Department, China agreed in 1994 to

accept applications for licenses in 12 additional cities, including Beijing.

China has been slow to actually grant the licenses, however. Before 1996,

foreign-invested firms doing business in China used “swap centers” to get

foreign exchange for approved current account transactions. Effective

February 1996, foreign-invested and domestic firms have the option of

using swap centers or purchasing foreign exchange from designated

Chinese banks, currently located in Shanghai, Shenzhen, Dalian, and

Jiangsu. These locations account for about 70 percent of China’s foreign

exchange transactions, according to the U.S. Treasury Department.

Limitations in the Scope of

Business for Foreign

Financial Institutions

Although China has made some progress in reforming its banking and

financial sectors, it continues to limit the scope of business for foreign

financial institutions. Currently, foreign financial institutions may only

Page 9 GAO/T-NSIAD-96-214
conduct transactions in foreign currency and are not allowed to do

business in local currency (or “renminbi”). This year, articles in the

Chinese press have said that the State Council has decided to allow some

foreign banks to engage in renminbi business in selected districts, such as

the Shanghai-Pudong district. According to these articles, foreign banks

would be limited to taking deposits and lending in local currency only to

foreign-funded companies or foreign-related firms. However, no action has

been taken on this announcement, according to the U.S. Treasury

Department.

Further limitations in foreign participation in the financial sector extend to

the stock market. China’s two stock exchanges are located in Shanghai

and Shenzhen. Both exchanges have introduced a variety of shares, but

foreign investors are prohibited from investing in most shares, thus

limiting the opportunity for foreigners’ portfolio equity investment. The

U.S. Treasury Department noted that at the end of 1994, shares available to

foreign investors accounted for less than 3 percent of total market

capitalization in the two stock exchanges. Additionally, foreign firms may

only establish representative offices and may only broker shares

purchased exclusively by foreign-invested companies or foreign residents.

Foreign firms must also work with a domestic broker on the basis of a

shared commission and may not underwrite local securities issues or act

as dealers or brokers in renminbi-denominated securities in the primary or

secondary market.

The Need for Further

Reform

There is widespread agreement that further liberalization of the Chinese

market is in the interest of U.S. businesses and will be necessary for China

to maintain its high growth rates. U.S. businesses and USTR have argued

that the United States should have access in China’s markets equivalent to

that which China receives in the United States. Currently, however, market

access for U.S. and foreign businesses in China is inhibited by Chinese

government measures to protect its state-run economy. According to a

May 1996 World Bank country study on China, sustaining growth and

maintaining economic stability will require further progress in the

government’s reliance upon market forces. While China has agreed to

remove certain barriers to trade in response to ongoing negotiations with

USTR, other trade barriers remain that limit exports and require continuous

monitoring to protect and further U.S. interests.

Page 10 GAO/T-NSIAD-96-214
Mr. Chairman and Members of the Committee, this concludes my prepared

statement, which incorporates comments obtained from the U.S. Trade

Representative, the Department of the Treasury and the Department of

Commerce. I will be happy to answer any questions you or other Members

of the Committee may have.

(711220) Page 11 GAO/T-NSIAD-96-214
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