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[Senate Hearing 111-764]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 111-764
 
                       FINDING COMMON GROUND WITH
                             A RISING CHINA

=======================================================================

                                HEARING

                               BEFORE THE

                     COMMITTEE ON FOREIGN RELATIONS
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

                             JUNE 23, 2010

                               __________

       Printed for the use of the Committee on Foreign Relations

  Available via the World Wide Web: http://www.gpoaccess.gov/congress/
                               index.html

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                COMMITTEE ON FOREIGN RELATIONS         

             JOHN F. KERRY, Massachusetts, Chairman        
CHRISTOPHER J. DODD, Connecticut     RICHARD G. LUGAR, Indiana
RUSSELL D. FEINGOLD, Wisconsin       BOB CORKER, Tennessee
BARBARA BOXER, California            JOHNNY ISAKSON, Georgia
ROBERT MENENDEZ, New Jersey          JAMES E. RISCH, Idaho
BENJAMIN L. CARDIN, Maryland         JIM DeMINT, South Carolina
ROBERT P. CASEY, Jr., Pennsylvania   JOHN BARRASSO, Wyoming
JIM WEBB, Virginia                   ROGER F. WICKER, Mississippi
JEANNE SHAHEEN, New Hampshire        JAMES M. INHOFE, Oklahoma
EDWARD E. KAUFMAN, Delaware
KIRSTEN E. GILLIBRAND, New York
                  David McKean, Staff Director        
        Kenneth A. Myers, Jr., Republican Staff Director        

                              (ii)        

  
?

                            C O N T E N T S

                              ----------                              
                                                                   Page

Hills, Hon. Carla A., former U.S. Trade Representative, 
  chairperson, National Committee on United States-China 
  Relations, Washington, DC......................................    23
    Prepared statement...........................................    25
    Responses to questions submitted for the record by Senators:
        John F. Kerry............................................    48
        Richard G. Lugar.........................................    50
        Russell D. Feingold......................................    53
Kerry, Hon. John F., U.S. Senator from Massachusetts, opening 
  statement......................................................     1
Lugar, Hon. Richard G., U.S. Senator from Indiana, opening 
  statement......................................................     4
Tyson, Laura, former chairperson of the President's National 
  Economic Council (NEC), professor, Berkeley HAAS School of 
  Businesss, Berkeley, CA........................................     6
    Joint prepared statement with Stephen S. Roach...............    10
    Joint responses with Stephen S. Roach to questions submitted 
      for the record by Senators:
        John F. Kerry............................................    44
        Richard G. Lugar.........................................    47

                                 (iii)

  

               FINDING COMMON GROUND WITH A RISING CHINA

                              ----------                              

                        WEDNESDAY, JUNE 23, 2010

                                       U.S. Senate,
                            Committee on Foreign Relations,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 2:38 p.m., in 
room SD-419, Dirksen Senate Office Building, Hon. John F. Kerry 
(chairman of the committee) presiding.
    Present: Senators Kerry, Casey, Shaheen, Lugar, and Risch.

            OPENING STATEMENT OF HON. JOHN F. KERRY,
                U.S. SENATOR FROM MASSACHUSETTS

    The Chairman. So, this very quiet hearing room will 
already--will, I should say, come to disorder so we can come to 
order. [Laughter.]
    Everybody's so quiet, it's amazing.
    Anyway, welcome. The hearing is now formally open. And I 
appreciate everybody's patience.
    I apologize for being late. We thought we had a couple of 
votes coming up at 2:30, and I was going to try and vote, and 
then come and open the hearing. And then, as is probably normal 
operating procedure here, the votes got put off, and we'll sort 
of wait to be interrupted, so we'll try to proceed ahead.
    So, thank you all, including my good friend and ranking 
member, Senator Lugar, for your patience and--before we open.
    Let me just say, at the top of this hearing, that President 
Obama has just taken decisive action in accepting the 
resignation of General McChrystal. And needless to say, I think 
all of us would have been happier if this distraction, 
interruption in the mission, had never occurred. I'm confident 
that there are a lot of folks in General McChrystal's immediate 
circle who would feel similarly. But, it has happened, and we 
are where we are. And I applaud the decisive, crisp, swift 
action that the President took in making the decision. I think 
it was appropriate that he did that, and I think he made the 
right decision, to accept the resignation.
    I also believe he made the right decision in selecting 
General Petraeus to take over that command. The President made 
it clear that no one is above the mission, and he's not going 
to accept anything less than the unified effort on this 
mission, within his administration and within the command 
structure. That's appropriate.
    So, I know General Petraeus, as we all do. We have great 
confidence in him. And he's a proven leader, and I'm confident 
that the skills that he brings as a soldier and as a general--
and also as a diplomat--will help to make this transition a 
smooth transition.
    American lives are on the line, and we simply can't afford 
a moment of distraction. It's time for all of us to be strictly 
focused on the mission itself.
    And this committee will be holding a series of hearings in 
order to evaluate that mission and keep the American people 
apprised of where we are, measured against the benchmarks that 
the committee has previously established.
    Today, we are gathered to discuss another important issue, 
and one that will be with us, in terms of the relationship, 
throughout this century certainly, probably the single most 
important relationship that will define a lot of global events 
over the course of this century, and that is, how we find 
common ground with a rising China.
    We're pleased to welcome two very respected experts: 
Ambassador Carla Hills and Dr. Laura Tyson. And, I might say, 
Zbig Brzezinski, former national security advisor of President 
Carter, was supposed to be here to join us this afternoon, but 
he had to cancel at the last moment, due to a health issue. 
But, I am told that he will be fine, and we look forward to 
welcoming him back here soon.
    How the United States, in concert with our friends and 
allies, responds to China's growing economic might, military 
capabilities, and political influence will significantly shape 
the international order of this century.
    Just about every global challenge that we face requires 
cooperation with China. Nuclear proliferation, global economic 
stability, climate change, just to mention a few. Clearly, 
building a positive and constructive relationship that can 
benefit both of our countries and enhance global prosperity and 
peace for decades to come is a central objective for all of us. 
That's why the administration has made an energetic effort to 
manage and to grow the partnership, through the Strategic and 
Economic Dialogue, as well as dozens of Cabinet-level visits to 
China.
    Still, United States-China relations, it is fair to say, 
remain a work in progress. We don't always see eye to eye. Our 
interests sometimes differ, and so do our approaches to shared 
concerns.
    What's more, both countries still mistrust each other's 
intentions on issues, such as China's defense modernization, 
the future of Taiwan, and the situation in Tibet. And there is 
still a great uncertainty about exactly how we will manage our 
growing economic interdependence.
    It's striking how much of the story of United States-China 
relations remains yet to be written. Looking forward, as China 
becomes more prosperous and powerful--and it will, absolutely 
and inevitably--we should not be surprised that it may also 
become more assertive. The question is how China will use that 
rising influence to shape global institutions, whether our 
cooperation can increase as China's stature does, and whether 
China will agree, or find it necessary and desirable, to take 
on global responsibilities as its own economic and security 
interests expand.
    This week's announcement on the renminbi is a case in 
point. China's decision to allow more flexibility in its 
currency is a welcome step, and many people would argue that 
it's a long overdue step, toward a rebalancing of the world 
economy. But, it was the subject of a very heated debate in 
China itself, and we will need to watch closely to see how 
vigorously Beijing implements its new policy.
    Of the two most important economies of the 21st century, 
ours is still the largest, China's is growing and will soon be 
the largest. So, the important question is to see how we can 
and should compete, but we also need to make certain that that 
competition takes place on a level playing field.
    We need to do more than just talk about difficult issues, 
such as indigenous innovation schemes, government procurement 
policies, and protecting intellectual property. We actually 
need to find meaningful actions between us that make a 
difference in the leveling of that playing field.
    In recent days, we have seen positive steps by China to 
stop the spread of nuclear weapons. And I think all of us 
appreciate China's vote for new sanctions against Iran at the 
United Nations. That's an important cooperative effort and an 
important measure of China's role in the world today. I hope 
that China will now join with us and other members of the 
Security Council in aggressively implementing these sanctions, 
and also in condemning North Korea's recent aggression against 
South Korea.
    Differences remain, however, and it's impossible to ignore 
them. We need to work to enhance our strategic dialogue, to 
increase trust and reach new understandings. And this 
engagement should include high-level military-to-military 
talks. And these talks shouldn't be switched off whenever one 
side perceives some kind of slight, the slight of the moment, 
if you will, to its particular interests. If we want to build 
our capacity to manage global crises together, those kinds of 
talks are even more important when tensions do arise.
    Even as we seek common ground with China, we will never 
abandon our values. We have to continue to encourage China to 
adhere to international human norms for rights--human rights, 
labor rights, political rights--and environmental protection. 
Based on my own conversations with China's top leaders, I 
believe that our commitment to these values can actually 
support China's own long-term efforts to build a harmonious 
society.
    And finally, while our companies will inevitably compete in 
many areas, there are challenges, such as climate change, where 
our two nations should be collaborating against a shared 
threat, and where, together, we have the ability to offer 
leadership to the world.
    As today's largest producer of greenhouse gas emissions, 
and history's largest cumulative emitter of greenhouse gases, 
China and America have a special responsibility to lead a 
global effort to reduce emissions, and, particularly, we can 
work together to develop the clean technologies, the new 
technologies, the clean and alternative energy sources, of the 
future. The truth is that no two nations have as much 
opportunity to set the mark for what we all should be 
achieving. And if China and the United States engage in this 
effort, and do so together, it is guaranteed that the rest of 
the world will follow, and be compelled, ultimately, to do so.
    To help us look into the future and navigate the thicket of 
issues facing America and China, we have two longtime China 
hands here with us today. Ambassador Carla Hill served as the 
U.S. Trade Representative under President George H.W. Bush, and 
she cochaired the influential Council on Foreign Relations Task 
Force on China, and currently chairs the National Committee on 
U.S.-China Relations.
    Dr. Laura Tyson is the former chair of the Council of 
Economic Advisors during the Clinton administration, and the 
former dean of the London Business School. Dr. Tyson currently 
serves on President Obama's Economic Recovery Advisory Board, 
and she is a professor at Berkeley's Haas School of Business.
    So, I invite both of our witnesses to feel free to 
summarize their comments, if they would. We will introduce the 
full text into the record as if read in full, and we look 
forward to your testimony. And, again, we're grateful to both 
of you for being here today.
    Senator Lugar.

              STATEMENT OF HON. RICHARD G. LUGAR,
                   U.S. SENATOR FROM INDIANA

    Senator Lugar. Mr. Chairman, I join you in welcoming our 
distinguished witnesses for this important hearing.
    China's rising financial and strategic power is a crucial 
factor in our approach to global economic, energy, and security 
problems. The United States must come to grips with the 
incredibly complex set of choices and opportunities that China 
represents.
    China is demanding a greater say in the management of the 
world economy through the G20 and other mechanisms. Its global 
leverage has increased as it has positioned itself as the 
leading creditor nation with more than 20 percent of the 
world's current account balance surplus.
    According to the most recent data, China is the United 
States Government's largest foreign creditor, holding 
approximately 23 percent of the $4 trillion we owe to other 
countries. The Chinese continue to buy United States bonds at a 
rapid pace, but we cannot count on this continuing 
indefinitely. Some thought must be given to how we work with 
China to establish a more sensible global balance that depends 
less on Chinese credit and demand by American consumers.
    The Treasury Department decided to delay publication of the 
congressionally mandated report on China's international 
economic and exchange rate policies until after the May 27th 
Strategic and Economic Dialogue with China and the June 5th G20 
meetings. Now that these meetings have concluded, Congress is 
eager to receive Treasury's assessment.
    I look forward to our witnesses's comments on China's 
recent decision to increase the flexibility of its exchange 
rate, which the Obama administration has welcomed. Is this a 
significant step, and can it have a positive impact on the U.S. 
economy?
    China remains an extremely important market for United 
States exports. Currently, China is our second-largest goods 
trading partner with more than $407 billion in two-way trade in 
2008. Since being admitted to the World Trade Organization in 
2001, China has become the United States third-largest export 
market, accounting for 5.4 percent of total U.S. exports.
    But this expansion of trade has not reached its full 
potential, in part because of impediments to American business 
activity in China. American businesses and agricultural 
exporters report that operating in China is becoming more 
difficult, not less. We are hearing increasingly frequent 
complaints about inconsistent application of rules, 
requirements for so-called ``indigenous innovation,'' rising 
nontariff barriers to trade, inconsistent market access, and 
lack of enforcement of intellectual property rights.
    Civil society within China continues to face immense 
challenges in promoting rule of law and human rights reform. 
While the administration and the Congress have been focusing on 
matters related to currency reform and the China-United States 
trade imbalance, other issues also warrant concern.
    On the military front, since announcement of the Taiwan 
arms sales, the United States has made attempts to reengage 
Beijing, including a recent overture by Secretary of Defense 
Gates on a reciprocal visit to China this June that was 
rebuffed by China's military.
    In East Asia, the United States continues economic 
sanctions against Burma, while China increases its economic 
engagement with the military junta. China has been helpful in 
encouraging Pyongyang to participate in the six-party talks. 
But at the same time, Beijing is apparently strengthening its 
assistance to North Korea, even after the sinking of South 
Korea's ship and the loss of 46 sailors.
    China's global advances to secure energy assets and 
increase its influence are perhaps most intense in its own 
backyard. China is dedicating massive financial and cultural 
resources to its neighbors in the region, with implications for 
traditional United States relations with Asian countries.
    Energy security is a strategic interest for both China and 
the United States. As the New York Times said on June 18, 2010, 
``as China counts on more years of global leadership in 
economic growth, global warming remains a secondary concern. 
Secure sources of energy to fuel that growth are what matter 
most.''
    I welcome the Obama administration's high-level attention 
to energy cooperation with China, which could benefit price 
stability and may enhance Sino-American cooperation on other 
international security issues.
    While all of this is underway, we must not lose sight of 
our strategic and economic relationship with Japan. As 
administration officials pursue new avenues to improve the 
United States-China relationship, we must maintain and 
strengthen our ties with Tokyo.
    I look forward to the hearing of the testimony of our 
distinguished witnesses, and our questions and answers.
    And I thank you, Mr. Chairman.
    The Chairman. Thank you very much, Senator Lugar.
    Dr. Tyson, if you would lead off, and then, obviously, 
Ambassador Hills.
    Thank you very much.

STATEMENT OF LAURA TYSON, FORMER CHAIRPERSON OF THE PRESIDENT'S 
   NATIONAL ECONOMIC COUNCIL (NEC), PROFESSOR, BERKELEY HAAS 
                SCHOOL OF BUSINESS, BERKELEY, CA

    Dr. Tyson. Certainly.
    The testimony I have submitted was done jointly with 
Stephen Roach, who is the chairman of Morgan Stanley Asia. I've 
worked with him for many years on issues of China and Asia.
    We focused on some of the policy priorities that were at 
the center of the most recent Strategic and Economic Dialogue 
discussions. They were the issues of rebalancing growth in the 
United States and China; related to that, the exchange rate 
itself and the policies and issues around the trade barriers 
that you have mentioned. Let me highlight some of our major 
recommendations on each of these issues.
    First of all, I think it is important to start with the 
view that I've heard shared by both of you that the Strategic 
and Economic Dialogue is an important forum in which the United 
States and China can discuss issues on which they can cooperate 
and also issues that divide them to come up with solutions.
    At the most recent meetings, a major focus of the 
discussion was global rebalancing. Now, I realize that 
rebalancing has become a common phrase among economists, but 
its meaning is not entirely obvious.
    At the height of the great credit and export bubble of 
2006-07, China was running a current account surplus of around 
11 percent, widely viewed to be unsustainable, and the United 
States was running a current account deficit of about 7 
percent, also widely considered to be unsustainable. So, both 
countries have to get their imbalances down. China has to get 
its current account surplus down and the United States has to 
get its current account deficit down. And that to the first 
approximation, is what ``rebalancing'' means.
    ``Rebalancing'' also means a change in growth strategies 
for both the United States and China. China has followed, very 
successfully, a very aggressive export-led strategy. The 
Chinese now talk about, and certainly the United States talked 
with China about, the need to shift their growth strategy to 
depend more on domestic demand and less on exports.
    That's what ``rebalancing'' means in China; it means 
bolstering domestic demand, particularly consumption, and 
relying less on exports.
    In the U.S. case, it's actually a bit more unclear what 
``rebalancing'' means. At a macrolevel, the current account 
deficit reflects the fact that for a very long period of time 
now, the United States has been spending more than it has been 
producing as a nation. So to reduce the current account deficit 
the United States must reduce its spending, particularly its 
spending on consumption, or increase its production or do some 
of both. And that's a different kind of challenge than the 
rebalancing challenge facing China.
    Much of our written testimony focuses on the fact that we 
think China is taking its rebalancing challenge seriously. If 
you look at its stimulus policies--and it cooperated quite 
actively with the United States in the G20 on the need for 
aggressive stimulus they are very much investment-oriented, 
and, as far as we can tell, the investment is directed to 
building the center and western regions of the country to 
enhance development and consumption at home, not to build 
export capacity for the rest of the world. This is not another 
export-led investment boom in China; this is an infrastructure-
led investment boom to encourage urbanization and move people 
from the countryside to the city. Building infrastructure in 
the countryside and moving people to the cities will encourage 
consumption by providing the rural population with the 
electricity they need to have sophisticated equipment in their 
homes and by facilitating their movement from place to place, 
thereby improving their access to consumer products and 
services.
    So, we believe that the stimulus policies reflect a real 
commitment, on China's part, to shift away from exports to 
domestic demand.
    We also think that what China is saying about its upcoming 
12th 5-year plan reflect rebalancing. China is introducing new 
health care systems, new social security systems, and new 
educational systems. These form the social safety net that has 
been absent, and without such programs, Chinese households have 
been encouraged to save to cover their own educational, health 
care, and retirement needs. So, if the Chinese, in fact, build 
out their new social safety net systems as they plan, Chinese 
households will save less and consume more, and that will go a 
long way to rebalancing growth. China is also talking a lot 
about the need to bolster labor-intensive services as part of 
the 12th 5-year plan. The United States tends to think of 
China's export strategy as an employment strategy. But, 
actually, China's economy has grown much faster than its 
employment. China's development strategy has actually not been 
particularly labor-intensive. To boost employment growth, China 
needs to encourage the development of labor-intensive services 
and it looks like they're on course to do that.
    As a result of these rebalancing policies, we believe that 
in the future the current account surplus in China will be 
significantly lower relative to its GDP than it was in 2006 and 
2007. It's already significantly down, and we believe it will 
continue to trend down. And we think that will be a very 
important contribution by China to the rebalancing part of the 
United States-China agenda.
    As far as the exchange rate is concerned, I will say a few 
things about that.
    First of all, we rewrote some of our testimony over the 
weekend based on what the Chinese announced; but, in fact, the 
first draft of our testimony would have suggested that they do, 
essentially, what they did--that they move back to the managed 
float exchange-rate regime that they first adopted in July 
2005. The regime in place between 2005 to 2008 had a 
significant effect on the renminbi dollar rate and on the 
renminbi multilateral trade-weighted exchange rate. There was 
significant progress on RMB flexibility during that period of 
time And this time, it looks like the Chinese authorities will 
allow even more movement of the rate within a broader bank.
    We think that China has decided to restore the 2005-08 
regime now for a number of reasons, many reasons in their own 
interest. Frankly, we think China's decision is a win-win 
situation. From the United States point of view, this is 
something we wanted, but it also is something good for the 
Chinese economy--because they were having trouble with 
speculative capital flows, with inflationary pressure and with 
sterilizing the effects of large purchases of dollar assets on 
China's money supply. All of these challenges become easier to 
address with an exchange rate which shows some movement over 
time.
    The new currency regime will also support China's 
rebalancing agenda. The exchange rate is a relative price. And 
if you adjust the relative price so foreign goods are cheaper, 
you will actually import more foreign goods. And if you 
actually make consumers in China wealthier because of the 
appreciation of the currency, there'll be more demand for 
domestic production. And that's essential for rebalancing.
    So, we think China's decision to restore its 2005-08 
exchange rate regime is a constructive step. We think it's a 
win-win step. And we can talk about the particulars of how they 
did it.
    Let me turn, then, to the trade agenda. I know that 
Ambassador Hills is going to talk about this in quite a bit of 
detail. I suspect we agree on all of this.
    I am concerned that China's trade and industrial policies 
of late seem to be changing in ways that reduce the access of 
foreign producers to China's market. And nontariff barriers not 
traditional tariffs are a growing problem. So-called indigenous 
innovation policies to support the development of China's high-
tech companies do not use traditional trade policies.
    China is not a signatory of the WTO's Government 
Procurement Agreement. The United States is. China is using 
preferential government procurement of high-tech products from 
Chinese companies to support their development. The fact that 
the stimulus package in the United States contained some 
controversial ``Buy America'' provisions was interpreted by 
some observers in China as a green light for their own 
preferential procurement practices. In addition to such 
practices, other nontariff barriers hindering the access of 
United States companies to China's market include national 
standards that favor Chinese companies, the lack of inadequate 
intellectual property protection for foreign producers, and 
explicit or implicit local content rules. Many United States 
companies say that they have to locate a significant share of 
their activity in China to gain access to its market.
    I think it is very revealing that access to China's market 
by United States companies was the first issue highlighted in 
the documents describing the S&ED meetings. Although the United 
States was not able to convince the Chinese to drop some of the 
most troublesome features of their indigenous innovation 
agenda, the United States did achieve some changes in China's 
product accreditation procedures that will make it easier for 
United States companies to bid for government contracts in 
China. This is an important first step in easing China's 
indigenous innovation policies. And the United States and China 
also agreed to ongoing, high-level discussions about trade 
concerns in high-technology products.
    During the S&ED discussions, China also committed to 
proposing a more robust offer to join the Government 
Procurement Agreement. I believe that China's participation in 
this agreement would be a major step toward easing United 
States-China trade tensions, especially in techology-intensive 
products.
    In our written testimony, we suggest that there's a bargain 
that can be made between the United States and China. China 
complains a lot about United States security controls on 
exports to China. The facts presented in our testimony indicate 
that such controls have very little effect on United States 
exports to China. So the United States can cooperate with China 
on this issue. Moreover, there are several recent studies 
recommending that the United States can and should ease its 
security controls on exports not just to China but to our other 
trading partners in order to bolster United States exports, 
without compromising United States security interests.
    So, as part of a trade deal with China, the United States 
could ease some of our security restrictions on exports to 
China. We could also offer to advance the recognition of China 
as a country with market-economy status in the WTO. China wants 
this very much. It's scheduled for automatic approval in 2016. 
The United States can move the date forward. We have been 
telling the Chinese that we will do so when they do something 
on their exchange rate. They have now done something by moving 
back to the 2005-08 managed exchange rate system. Now we can 
say, ``Yes, let's work with you on getting earlier market-
economy status. Let's work with you to reduce security controls 
on U.S. exports. You, in turn, should make a serious proposal 
to join the Government Procurement Agreement and continue to 
curb the use of preferential procurement policies to foster 
indigenous innovation.'' I think this is an outline of the kind 
of bargain we might be able to strike in our trade negotiations 
with China.
    Finally, since I've run out of time, just let me add two 
things.
    First, it is very important for the United States to work 
with our other trading partners in trying to influence China. 
One of the reasons China moved, this week on the exchange rate 
is not because we were pressuring the Chinese authorities but 
because many other G20 nations were doing so well. There is 
widespread agreement within the G20 that as part of global 
rebalancing, China needs a more flexible exchange rate system 
that allows its currency to appreciate over time in response to 
market forces. Many of China's other trading partners, 
particularly in Europe, are also concerned about the nontariff 
barriers that are part of China's indigenous innovation agenda. 
Whenever we can work with China's trading partners, we need to 
do that.
    Second, I think we should work on forging a new 
transpacific partnership agreement that can help move the 
United States back into the center of regional trade 
negotiations in Asia. During the last few years, many regional 
and bilateral trade agreements have been signed throughout 
Asia, and the United States has not been at the table. If the 
United States becomes the champion of a free trade area for the 
Asia Pacific through the transpacific partnership, it would 
give the United States a tremendous opportunity to participate 
in the benefits of freer trade and investment flows.
    And, by the way, on green trade, that is trade related to 
environmental products and services; remember that APEC itself 
was the organization that first negotiated a sectoral agreement 
for free trade in information technology and this agreement was 
later adopted by nations around the world. APEC might be able 
to lead again on a sectoral free trade agreement in green goods 
and services and such an agreement complement our efforts to 
cooperate with China on solving global environment challenges.
    And finally, let me add that our written testimony 
addresses the question of whether China might adjust its 
holdings of U.S. Government securities in response to growing 
tensions in United States-China relations. For example, if the 
United States pursues a policy the Chinese deem to be an 
assault on their sovereignty, such as imposing large punitive 
tariffs on Chinese products to force China to adjust its 
exchange rate, would China respond by selling a significant 
amount of these assets, driving the dollar down and interest 
rates up? We conclude that there is reason to think that they 
would, that we tend to exaggerate the costs to them of using 
this form of retaliation and that we tend to underestimate the 
strength of their nationalist sentiment in response to what 
they could consider unfair and unwarranted unilateral U.S. 
pressure. I think we have to keep these conclusions in mind 
both in military affairs and in economic affairs.
    Let me stop there.
    [The prepared statement of Dr. Tyson follows:]

 Joint Prepared Statement of Laura Tyson, SK and Angela Chan Professor 
     of Global Management, Haas School of Business, University of 
 California, Berkeley, CA, and Stephen Roach, Chairman, Morgan Stanley 
                                  Asia

    Chairman Kerry, Ranking Member Lugar and distinguished members of 
the committee, thank you for the opportunity to testify before your 
committee on this important relationship.
    The United States-China economic relationship is the most important 
bilateral economic relationship in the world. China is the third-
largest and the fastest growing major economy in the world. At current 
growth rates, it will pass Japan later this year and reach the size of 
the U.S. economy by 2020 or sooner. The United States is China's 
second-largest export market and China is America's third-largest 
export market--and has been the fastest growing market for U.S. exports 
since the late 1990s. China accounted for 18 percent of U.S. imports 
and for 36 percent of the U.S. trade deficit over 2008-09. China has 
emerged as the center of a complex global supply chain for manufactured 
goods in Asia. A significant share of the value of U.S. imports from 
China represents intermediate inputs and components produced throughout 
Asia and assembled into final products for export to the us. China is 
the largest destination for foreign direct investment, much of it from 
companies headquartered in the us. More than half of all U.S. imports 
from China come from companies that are partially or completed owned by 
foreigners, including U.S. companies. This share is significantly 
higher for U.S. imports of high-technology products like computers and 
smart phones. And China has $2.4 trillion of foreign exchange reserves, 
by far the largest such portfolio in the world. Most of these reserves 
are held in dollars or dollar-denominated assets. China owns about 25 
percent of all U.S. Treasury debt held by foreign investors.
    China and the United States both reap substantial returns from the 
large trade and capital flows that link their economies. But these 
cross-border flows are lopsided: The United States runs a large trade 
deficit with China and China runs a large trade surplus with the United 
States; the United States is a debtor and China is a creditor. The 
United States relies on its deficit with China as a means to satisfy 
spending of consumers and businesses and China relies on its surplus 
with the United States as a means to sustain its production and export-
oriented economy. The unbalanced nature of these flows complicates the 
relations between the United States and China and contributes to 
tensions between them. Despite these tensions, however, both countries 
are major beneficiaries of globalization and both share interests in 
promoting a strong global recovery and fostering sustainable and better 
balanced global growth. The Strategic and Economic Dialogue (S&ED) is 
an important forum through which the United States and China can 
ameliorate the tensions in their relationship and cooperate on policies 
to foster a balanced and prosperous world economy. In addition, the 
United States and China are cooperating within the G20 and other 
multilateral institutions and are committed to strengthening these 
institutions to address shared global challenges.
    In this testimony, we examine some of the U.S. policy priorities 
that were the focus of the most recent S&ED meetings: macroeconomic 
policies to promote and rebalance global growth; the currency issue--
especially in light of recent adjustments in China's exchange rate 
regime; and policies to reduce barriers to trade. We also assess the 
possibility that China might sell some of its U.S. Government debt or 
slow down its purchases of such debt to influence the outcome of a 
foreign policy dispute with the United States or to retaliate against a 
U.S. action that China deems to be an assault on its sovereignty. We 
conclude with recommendations for U.S. policy.

I. UNITED STATES-CHINA COOPERATION TO PROMOTE A STRONG GLOBAL RECOVERY 
                    AND SUSTAINABLE BALANCED GROWTH

1. China's Rebalancing Challenge
    In recent G20 discussions and in the latest S&ED discussions, China 
has committed to cooperate with the United States to promote a strong 
global recovery and to foster more balanced, sustainable global growth. 
Chinese authorities have adopted ambitious policies that are consistent 
with this commitment and that have already delivered measurable 
results. As a result of its unprecedented monetary and fiscal stimulus 
measures, China recovered more rapidly than expected from the global 
slowdown in 2009, ending the year with a growth rate of 8.7 percent. 
China's strong recovery boosted global growth by providing strong 
demand for exports from the United States and from China's other 
trading partners. U.S. exports to China have rebounded much more 
rapidly than overall U.S. exports during the last year and are now 
about 20 percent above precrisis levels. U.S. exports to China are 
still growing much more rapidly than U.S. exports to the rest of the 
world. During the first quarter of 2010, U.S. merchandise exports to 
China grew by almost 50 percent from year-earlier levels while U.S. 
exports to the rest of the world grew by about 20 percent. China is now 
the third-largest and most rapidly growing market for U.S. exports, 
with double-digit growth across a wide range of U.S. products from 
high-tech manufactured goods to agricultural goods. Whether China's 
recent stimulus actions will also deliver on its commitment to foster 
more balanced future growth, however, is not certain. Faced with a 
dramatic collapse in China's export markets in the wake of global 
recession, Chinese authorities had little choice but to reorient their 
growth policies in the short run. The unprecedented 11.9 percent drop 
of world merchandise trade in 2009 choked off China's long vigorous 
export sector. In the short span of 7 months Chinese exports went from 
boom to bust--a +26 percent year over year increase in July 2008 gave 
way to a ^27 percent decline by February 2009. Real GDP growth 
screeched to a standstill as measured on a sequential quarterly basis, 
and over 20 million migrant Chinese workers lost their jobs in export-
led Guangdong province. For a nation long fixated on labor absorption 
and social stability, this was the functional equivalent of China's 
dreaded recession and called for a massive stimulus response to bolster 
domestic demand.
    Within domestic demand, China's stimulus measures have focused 
primarily on fixed investment. There are concerns among China's trading 
partners that this investment is adding excess capacity in 
manufacturing that will feed another surge of exports--and a renewed 
widening of China's trade surplus--as the global economy recovers. In 
fact, most of China's stimulus investment has been directed to massive, 
multiyear infrastructure projects especially in the western and central 
regions of the country. (More than 70 percent of China's stimulus 
package has been devoted to infrastructure projects, Sichuan earthquake 
reconstruction and public housing projects.) The surge in 
infrastructure spending in turn has sparked a pickup in private-sector 
investment by augmenting demand for goods and services provided by 
private firms, especially those in the manufacturing sector. Rapid 
growth in investment spending has augmented household income growth, 
especially in urban areas; moreover, growth in household incomes along 
with targeted proconsumption incentives for selected consumer durables 
has supported solid consumption growth.
    On the surface, the rebalancing of China's growth toward domestic 
demand appears to be confirmed by recent data. In 2009, consumption 
accounted for 4.6 percentage points or about half of China's GDP 
growth, and in the first quarter of 2010, consumption contributed a 
record 6.2 percentage points to China's GDP growth. In 2009, China's 
current account surplus as a share of GDP fell to 6.1 percent, down 
sharply from its peak of 11 percent in 2007, and dropped further to 
only about 1 percent of GDP in the first quarter of 2010. China's 
overall trade surplus as a share of its economy has fallen sharply by 
about half during the last 2 years.
    Some observers express concerns that these trends are temporary and 
that the rebalancing of China's growth strategy will end when the 
global economy recovers and global markets for China's exports rebound. 
In fact, the May trade surplus widened to $19.5 billion from a surplus 
of $1.7 billion in April and a modest deficit in March. These results 
are consistent with these concerns and suggest that it may be premature 
to celebrate the onset of a sustained structural rebalancing of the 
Chinese economy. But we believe that China's rebalancing is likely to 
continue over the long term out of both design and necessity. For an 
externally dependent Chinese economy, the latter motive is especially 
germane in the post-crisis era--an era that is likely to face lingering 
headwinds from sluggish demand in the developed world. If there was any 
doubt about the state of global demand in the aftermath of the global 
recession in 2009, recent problems in Europe should dispel a false 
sense of optimism. First, the United States and now Europe--the growth 
in global final demand that was the sustenance of China's export growth 
is in serious trouble. And there are compelling reasons to believe that 
such trouble will not be fleeting--that it will be an enduring feature 
of the post-crisis environment for several years to some. In order to 
avoid a sustained shortfall of export-led growth and the social 
instability it would imply, China needs a new source of growth. And it 
needs one quickly.
    A significant rebalancing of the Chinese economy is really the only 
answer to China's post-crisis wake-up call. GDP growth needs to shift 
away from the export- and investment-led dynamic that powered the 
economy so successfully over the past 30 years toward the sector that 
has been left behind--internal private consumption. At their peak in 
early 2007, exports and fixed investment totaled 75 percent of Chinese 
GDP--more than double the 35-percent share going to private 
consumption. To some extent, the low share of consumption is the result 
of high household precautionary saving rates necessitated by the lack 
of a social safety net--social security, private pensions, medical and 
unemployment insurance are all lacking for most Chinese citizens. But 
consumption also has been held back by slow income growth, with wages 
increasing much more slowly than productivity and rising profits 
feeding high enterprise saving rates. Enterprises now generate more 
than half of China's saving.
    There are signs that this situation may be changing. There have 
been recent significant increases (20 percent or more) in minimum wages 
in key places like Beijing and Guangdong province, and several strikes 
have ended with sizeable wage increases. The number of young people 
entering the workforce is slated to decline by almost 30 percent over 
the next 10 years, and survey evidence indicates that increasingly 
scarce younger workers may expect higher wages and better working 
conditions before they are willing to migrate to factory jobs far from 
their homes. Fully 40 percent of China's population remains in low-
productivity agriculture, so there is still a lot of surplus labor. But 
there are growing signs that the reservation wage for surplus labor is 
increasing, and this may be another factor that helps rebalance China's 
future growth.
    China's infrastructure-led stimulus policies are building a 
foundation for strong future growth in domestic consumption through job 
creation and through projects that not only bolster the development 
potential of the western and central regions of the country but also 
reduce physical bottlenecks to rural consumption and rural-urban 
migration. These are the regions where most of China's surplus labor is 
located. There is good reason to believe that China will use its 
upcoming 12th Five-Year Plan (2011-16) to lay out a broad framework to 
continue this proconsumption rebalancing. The 5-year planning cycle has 
long been Beijing's principal means for refocusing and redirecting the 
economy. That purpose seems all the more meaningful in a post-crisis 
global climate that challenges one of the critical assumptions that has 
underpinned the export-led growth dynamic for 30 years--the vigor of 
support from external demand.
    China's proconsumption plan is likely to have three major macro 
goals--to reduce precautionary household saving; to temper widening 
income disparities; and to uncover new sources of job creation. Each of 
these goals will require major policy initiatives. On the saving front, 
it's all about the social safety net--namely social security, private 
pensions, medical, and unemployment insurance. China has taken only 
small steps in these areas. It now needs to take big convincing steps 
in order to reduce the excesses of fear-driven precautionary saving. At 
the same time, income inequality can only be addressed if China tackles 
the serious problem of lagging rural incomes--the some 700 to 800 
million Chinese who still live at relatively impoverished income levels 
in the countryside. Several policy initiatives will be required here--
especially tax rebates to rural families, rural land and ownership 
reforms, IT-enabled connectivity of agricultural communities, and 
ongoing incentives to sustain rural-urban migration, which is essential 
to boosting agricultural productivity. Finally, on-the-job creation 
front, China needs a blueprint for the development of large-scale, 
transactions-intensive services industries such as wholesale and retail 
trade, domestic transportation, supply-chain logistics, and leisure and 
hospitality. China needs to shift its development strategy away from 
laborsaving manufacturing for export toward labor-intensive services 
for domestic consumption.
    If the 12th Five-Year Plan contains half of the initiatives 
outlined above, we believe that China will make important progress in 
shifting sustained support of its macroeconomy from external to 
internal demand. As a share of GDP China's current account surplus has 
already shrunk from an 11-percent peak in 2007 to slightly over 1 
percent in the first quarter of 2010. Although a significant portion of 
this reduction is cyclical as we noted above, there is good reason to 
believe that China's external imbalance has peaked and that a consumer-
led rebalancing will mean a significantly lower current account surplus 
in the years ahead.
    Nor do we believe that Chinese families are culturally predisposed 
toward high and rising personal saving--suggesting that this 
transformation will take decades to occur. With the right incentives 
and job-creation initiatives, we would not be surprised to see the 
consumption share of the Chinese economy rise from 35 percent currently 
to the 42-percent to 45-percent range by 2016--still low by 
international standards but a major increase from current levels. The 
key for the 12th Five-Year Plan is to move the needle from the old 
growth model to the new growth model--setting in motion a powerful 
rebalancing momentum that will sustain Chinese growth for years to 
come.
2. The Role of China's Exchange Rate Policies in Global Rebalancing
    Exchange rate policy has proved to be a lightening rod in United 
States-China economic relations in recent years. We applaud China's 
June 19 announcement to end the crisis-induced repegging of the 
renminbi-dollar cross-rate which has been in place since July 2008. By 
returning to the ``managed float'' foreign exchange regime which it 
first adopted in July 2005, China has signaled both flexibility and 
practicality in dealing with a very contentious global issue. Although 
the full extent of the resulting Chinese currency adjustment is 
unknown, it should be stressed that this is the same regime that 
resulted in a 20-percent appreciation of the renminbi versus the dollar 
in the 3 years ending July 2008. Under the presumption of a sustainable 
recovery in the global economy, there is good reason to expect that a 
resumption of gradual RMB appreciation will track a similar trajectory 
in the years ahead. China should be commended for having taken a very 
important first step in the right direction.
    It was actually an auspicious time for China to act--not just 
because of mounting global pressure on the eve of the G20 meeting in 
Toronto but also because market conditions may work in its favor. 
Recent turbulence in global currency markets caused by the flight from 
the euro to the dollar, combined with China's reduced trade and current 
account surplus, gives China an opportunity to reform its currency 
regime at a time when there is less upward market pressure on the RMB.
    China's shift in currency policy also seems well aligned with the 
broader strategic objectives of the Obama administration. In recent 
congressional testimony (June 10, 2010), Treasury Secretary Timothy 
Geithner argued that over time a more flexible market-driven RMB will 
be good for the global economy because it will facilitate more balanced 
and sustainable global growth. He also argued that it would serve 
China's interests because it will support China's rebalancing agenda 
and because it will enable China to pursue a more independent monetary 
policy. Secretary Geithner did not argue that greater flexibility in 
the RMB exchange rate would reduce the U.S. bilateral trade deficit 
with China. Nor did he call for an appreciation of the RMB. Rather he 
noted that a stronger RMB as the result of market forces within a more 
flexible exchange rate system would benefit China and promote global 
rebalancing. We agree with the conceptual arguments and recommendations 
made by Secretary Geithner in his written testimony and we applaud his 
discussion of China's currency policy from a multilateral perspective 
rather than from a contentious and misleading bilateral one.
    In that vein, it is essential to put the currency issue in the 
context of the world's broader rebalancing imperatives. An RMB-dollar 
adjustment is not the only option that China has to address its fair 
share of the global rebalancing agenda. The key challenge for all 
unbalanced economies--including China and the United States--is to 
reduce their global imbalances. That is true whether those imbalances 
take the American form of a saving gap and current account deficit or 
the Chinese form of a saving excess and a current account surplus.
    In the case of China, the structural policies that we suspect are 
likely to be featured in the upcoming 12th Five-Year Plan could well be 
far more effective than the more circuitous option of a currency 
adjustment. It is up to China to decide which of those options--or 
which combination of them--works best. The rest of the world has a 
right to insist that China face up to its saving imbalance, but does 
not have the right to insist on the precise mechanism that China 
employs to accomplish this task. The same argument, of course, also 
applies to the tactics and strategy that the United States employs to 
cut its budget deficit and boost domestic saving. While the rest of the 
world has a right to insist that America take its rebalancing 
imperatives seriously, it is the sovereign right of the United States 
to decide on the best ways to accomplish this objective.
    That's not to say there isn't a compelling domestic rationale for 
China to allow a stronger RMB. Indeed, RMB appreciation would certainly 
complement China's domestic rebalancing agenda both by boosting the 
purchasing power of Chinese consumers and by encouraging Chinese 
producers to shift production away from exports toward domestic 
markets. Moreover, a stronger currency would temper the impacts of 
imported inflation--hardly inconsequential in light of China's recent 
cyclical upsurge in inflation to 3.1 percent in May 2010.
    Reforming the exchange rate regime in a way that allows the RMB to 
appreciate gradually in response to market forces also gives China time 
to liberalize its capital markets to prepare for greater exchange rate 
flexibility. We do not endorse the view expressed by many that China 
should make an immediate large upward adjustment in the RMB-dollar 
exchange rate. China's June 19 policy pronouncement, which stresses a 
return to precrisis ``floating bands,'' all but rules out such an 
action. And with good reason: As a developing economy with a still 
embryonic financial system, China must continue to focus on financial 
stability and potential vulnerability to speculative capital flows. For 
that consideration alone, there is ample justification for China to 
view a tightly managed band on the dollar-RMB relationship as an 
important stability anchor.
    Bilateral political tensions aside, we agree with Secretary 
Geithner that it is critical to assess the currency ramifications of 
global rebalancing from a multilateral perspective. In this regard, it 
bears noting that on a broad trade-weighted basis, the RMB is up 7 
percent (in real terms) from its late 2009 low and up 19 percent from 
its early 2005 low. In other words, despite the repegging of the RMB to 
the dollar over the past 2 years, it is factually incorrect to maintain 
that the RMB has not moved in a broader global context. It is equally 
important to stress that there are long and uncertain lags associated 
with the impacts of a shift in relative prices between China and the 
rest of the world on global imbalances. The example of Japan in the 
late 1980s raises serious questions about whether a sizeable 
appreciation of the RMB against the dollar over the next few years 
would have a sizeable effect on these imbalances. After all, while the 
yen more than doubled in value relative to the dollar from early 1985 
to late 1988, Japan's outsize current account surplus barely budged.
    China's decision to return to its precrisis system and allow the 
RMB to fluctuate against the dollar within a tightly managed band is 
unlikely to eliminate U.S. concerns about the RMB-dollar exchange rate. 
A renewed post-crisis rebound of Chinese exports, in conjunction with 
sluggish U.S. job growth and unacceptably high unemployment, has fueled 
congressional frustrations about the persistence of a large bilateral 
trade deficit with China. As a result, pressures on China for a major 
RMB revaluation--or for the U.S. Treasury to name China as a currency 
manipulator if that doesn't occur--have intensified. Many Members of 
Congress believe that a sizeable RMB appreciation relative to the 
dollar would be an effective way to ease the plight of America's 
beleaguered middle class. They also believe that if China does not act 
voluntarily to relieve those pressures, the United States should take 
offsetting action. At least, China's June 19 adjustment of its currency 
policy sends an important signal to U.S. policymakers that the Chinese 
leadership takes these concerns seriously.
    Unfortunately, a significant appreciation of the RMB-dollar 
exchange rate--or the countervailing trade sanctions that might occur 
in its absence--might well backfire. Much of the growth in U.S. imports 
from China has been the result of production moving to lower cost China 
not from the United States but from other higher cost foreign countries 
especially in Asia. China has become the center of a global supply 
chain that enhances efficiency, keeps production costs down and 
supplies U.S. consumers with attractively priced products, purchased in 
large amounts by low- and middle-income families. A significant share 
of the value of U.S. imports from China represents the value of 
components produced in other countries and assembled in China for sale 
in the United States. China's share of the value-added for some 
products may be only 20-30 percent of the total value of U.S. imports 
from China. Tariffs imposed on Chinese exports to the United States in 
an effort to offset the so-called RMB currency subsidy would raise the 
prices of these products for U.S. consumers and drive their production 
not back to the United States but to other emerging market countries, 
reducing the efficiencies of the supply chain and increasing production 
costs. The increase in prices on U.S. imports that resulted would be 
the functional equivalent of a tax hike on both U.S. companies and 
American consumers.
    Moreover, there are other equally serious analytical pitfalls to a 
bilateral assessment of the China problem. Yes, China accounts for the 
largest piece of America's trade deficit--some 36 percent of the 
average merchandise trade gap over 2008-09. But the key point to stress 
here is that the United States had trade deficits with over 90 
countries during the same period--a multilateral imbalance that stems 
from the unprecedented shortfall in U.S. saving discussed below. 
Lacking its own saving, the only way for the United States to keep 
growing is to import surplus saving from abroad and run a large current 
account and multilateral trade deficit in order to attract foreign 
capital. The Chinese piece may account for the largest share of this 
multilateral imbalance but that is more likely traceable to conscious 
outsourcing decisions of U.S. multinationals and strong consumer 
preferences for low-cost, high-quality goods made in China than to 
unfair trading practices. The bottom line is that America's 
multilateral trade imbalance cannot be addressed by putting pressure on 
a bilateral foreign exchange rate with China.
    Finally, it is important to emphasize that if the U.S. Congress 
were to impose trade sanctions on imports from China, it is highly 
likely that China would retaliate. That retaliation could take one of 
three forms: lodging a WTO complaint; imposing tit-for-tat trade 
sanctions on U.S. exports to China; or reducing demand for U.S. 
Government securities. The latter two options would hardly be 
inconsequential for the United States. Tariffs on U.S. exports to China 
would hit America's third-largest export market--a serious problem for 
the Obama administration's goal of doubling U.S. exports over the next 
5 years. Similarly, reduced Chinese buying of U.S. Treasuries would be 
highly problematic for the funding of the Federal deficit at attractive 
interest rates and could trigger a spike in U.S. interest rates, a 
sharp drop in the dollar's value and renewed instability in global 
financial markets. (The possibility that China might respond to U.S. 
pressure on its exchange rate policy by adjusting its demand for U.S. 
Treasuries is discussed below.)
3. The U.S. Rebalancing Challenge
    Rebalancing growth was a major topic at the recent S&ED meetings 
and U.S. officials agreed on the need to rebalance growth of the 
American economy away from consumption and large Federal Government 
deficits toward higher household saving rates, greater reliance on 
exports and investment, and sustained deficit reduction. U.S. officials 
emphasized the Obama administration's multiyear plan to achieve $1 
trillion in deficit reduction over the next decade. The plan includes 
freezing nonsecurity discretionary spending for 3 years, reducing 
defense spending in Iraq and Afghanistan, and allowing the 2001-2003 
tax cuts for households earning more than $250,000 to expire. According 
to the administration's latest projections, this plan would reduce the 
deficit from 10.6 percent of GDP in 2010 to 3.9 percent by 2015, a 
record 5-year reduction that would occur despite an average 
unemployment rate of 7.9 percent during the period. If adopted, this 
plan would be a significant step toward rebalancing the U.S. economy, 
but it would leave the United States with a projected average deficit 
of 3.9 percent of GDP between 2015 and 2020, and it would not stabilize 
the federal debt to GDP ratio, which would continue to rise through 
2020 and beyond. As long as the debt to GDP ratio is rising, U.S. 
fiscal policy is not on a sustainable long-run path. This could prove 
problematic for global investors, including the Chinese, who are 
currently willing to purchase U.S. Government debt at interest rates 
that are at or below historical averages.
    During the S&ED discussions, U.S. officials assured their Chinese 
counterparts that the Obama administration is committed to reducing the 
deficit to 3 percent of GDP and stabilizing the debt to GDP ratio by 
2015. President Obama has created a special bipartisan National 
Commission on Fiscal Responsibility and Reform charged with the task of 
proposing additional spending cuts and/or revenue increases to bring 
the primary budget deficit into balance and thereby stabilize the debt 
to GDP ratio in that year. Primary balance requires that total Federal 
Government spending excluding interest payments on the debt, equal 
total Federal Government revenues. According to the administration's 
latest projections, the primary deficit will be around $174 billion in 
2015; by contrast, according to the most recent Congressional Budget 
Office projections, the primary deficit will exceed $250 billion in 
that year, and many private sector projections are even larger.
    A recent study by the Center for American Progress (CAP) found that 
closing a primary budget gap of $250 billion in 2015 by spending cuts 
alone would require a cut of almost 7 percent in every area of federal 
spending, except interest payments on the debt. If cuts in Social 
Security spending, additional cuts in Medicare and Medicaid spending 
beyond those in the health care reform, and additional cuts in defense 
spending beyond those in the President's budget are excluded, balancing 
the primary budget by spending cuts alone would require a 16-percent 
cut in the rest of government spending. CAP estimates that closing the 
primary budget gap by revenue increases alone would require a 7.3-
percent increase in all federal taxes and fees. If those making less 
than $250,000 a year are excluded, taxes and fees collected from those 
making more than $250,000 a year and from U.S. corporations would have 
to increase by almost 25 percent. These calculations make it very clear 
that balancing the primary budget by 2015 will require some combination 
of very painful spending cuts and revenue increases.
    The Commission is charged with making recommendations in December 
2010. Given the size of the fiscal problem and the highly charged 
partisan atmosphere--a climate that may well worsen after the November 
elections--it is unlikely that the Commission will be able to agree on 
major recommendations and that such recommendations will be adopted by 
Congress. So even though the deficit as a share of GDP is likely to 
decline significantly as the economy recovers and as temporary stimulus 
and recovery measures die out, the United States will face significant 
challenges to deliver on its commitment of rebalancing the U.S. economy 
through fiscal consolidation.
    Rebalancing U.S. growth also requires more than a sustainable 
fiscal path. It also requires reducing the gap between the growth of 
spending and the growth of income in the United States, and this 
requires an increase in national saving. America's net national saving 
rate--the sum total of deprecation-adjusted savings of households, 
businesses, and the government sector--turned negative in 2008 before 
plunging to a record low of ^2.6 percent of national income in 2009. 
This is the most serious shortfall of domestic saving by a leading 
nation in modern history. Just as China must reduce its saving surplus 
to deliver on its rebalancing commitments, the United States must 
reduce its saving gap to do the same. Between 2000 and 2008, U.S. 
saving declined both because of increases in the federal budget 
deficit--a measure of government disserving--and because of a dramatic 
drop in household saving. During the recession, the household saving 
rate has recovered somewhat, rising from essentially zero in 2007 to 
about 4 percent in 2008-2009 before falling back to about 3.6 percent 
in April 2010. Many economists predict that the household saving rate 
will rise during the next several years to its historical average of 
about 7 percent, but there is considerable uncertainty about this. In 
the S&ED discussions, the United States promised to introduce policies 
to reinforce rising household saving rates but did not offer any 
specifics, and policies tried in the past have not been very effective.
    As part of its rebalancing agenda, the administration has also set 
a goal to double U.S. exports over the next 5 years and has introduced 
supporting policies and organizational changes. An active U.S. trade 
policy to reduce access barriers to U.S. exports in rapidly growing 
emerging markets including China is essential to realizing this goal. 
We discuss trade policy in United States-China relations in the next 
section of this testimony. Unfortunately, since Europe is a major 
destination for U.S. exports and since European companies are major 
competitors of U.S. companies in China and other rapidly growing export 
markets, the recent slowdown in Europe and the sharp drop in the value 
of the euro pose serious downside risks to strong U.S. export growth 
over the next few years.
    Nor would such growth ensure a sustained reduction in the U.S. 
trade deficit and current account deficit as the economy recovers. The 
size of these deficits depends on both exports and imports and reflects 
the size of the U.S. saving gap, or the gap between how much the U.S. 
produces and how much it spends. During the recession, this gap, as 
measured by the current account deficit as a share of GDP, declined 
significantly to 2.9 percent in 2009 from its 2007 peak of 6 percent of 
GDP. This drop in the saving gap is primarily the result of a sharp 
reduction in private sector spending relative to private sector income, 
as U.S. households and businesses have curtailed spending to rebuild 
balance sheets and deleverage their financial positions. Despite the 
retrenchment in private sector spending relative to income, the current 
account deficit, which is a measure of the national saving gap, has 
remained sizeable because the government deficit has increased as a 
result of tax cuts and spending increases to combat the recession.
    Most forecasters predict that the United States will continue to 
run a significant current account deficit around 3 percent of GDP for 
the next several years if the fiscal deficit is reduced and if the 
household saving rate increases from its historic lows of the 2002-2007 
period. A deficit of this size would roughly stabilize foreign U.S. 
debt as a share of GDP. Provided the United States convinces China and 
other global investors of its commitment to a sustainable long-term 
fiscal path, it is likely that the United States can finance a current 
account deficit of this size with reasonable long-term interest rates 
on U.S. Government debt in the 4-5-percent range.
    What happens to the U.S. trade and current account deficits and to 
U.S. borrowing requirements from the rest of the world depends 
primarily on what the United States does to increase private saving and 
to reduce government dissaving. China's trade and exchange rate 
policies are of second-order importance. If the United States fails to 
sustain a significant reduction in its saving gap, its trade and 
current account deficits will rise again as a share of GDP as the 
economy recovers. That will be the case even if China succeeds with its 
own rebalancing agenda and reduces its current account surplus as a 
share of its GDP and even if China moves to a pure market-determined 
exchange rate. The risk in this case would be that of an ``asymmetrical 
global rebalancing''--a scenario in which China makes more progress in 
transitioning to a consumer-led economy than the United States makes in 
closing its saving gap.
    The odds of an asymmetrical rebalancing scenario should not be 
minimized. China's stimulus policies and the likely components of the 
12th Five-Year Plan indicate that China could well make significant 
progress in rebalancing its economy over the next several years. In 
contrast, the stimulus policies in the United States, while essential 
and justifiable to combat the recession, have exacerbated the long-run 
saving gap and have not rebalanced growth away from consumption toward 
exports and investment. Moreover, given the partisan atmosphere in 
Congress, passage of a credible multiyear deficit reduction plan to 
reduce the Nation's saving gap on a sustained basis once the economy 
has recovered seems unlikely, at least in the near future.

 II. AN ACTIVIST TRADE POLICY TO LEVEL THE PLAYING FIELD IN CHINA AND 
                        SUPPORT U.S. REBALANCING

    China is now the largest exporter and the third-largest importer in 
the world. It is the third-largest and fastest growing market for U.S. 
exports in a wide range of products. If the United States is to succeed 
in rebalancing its growth--shifting from credit-driven consumption and 
housing toward investment and exports--continued rapid growth in U.S. 
exports to China is essential. China also receives a major share of the 
foreign direct investment of U.S. multinational companies, many of 
which have extensive and growing operations there. Offshore Chinese 
production platforms are critical to efficiency solutions for high-cost 
U.S. manufacturers and support their production, employment, profits, 
R&D and investment in the us. Access to China's large and growing 
market is a significant factor in the success of many U.S. businesses, 
both large multinational companies and many small- and medium-sized 
companies as well. Reducing barriers that impede the access of U.S. 
companies to China's markets is and should be a major objective of U.S. 
trade policy. The Obama administration rightly accorded priority to 
this goal in the recent S&ED discussions, focusing in particular on the 
effects of China's innovation policies, government procurement 
policies, and foreign direct investment policies on American companies 
exporting to and/or producing in China.
    During the last few years, many American companies (along with 
European and Japanese companies) have raised concerns about China's so-
called ``indigenous innovation'' policies to promote the development of 
Chinese owned technology and intellectual property and to reduce 
China's dependence on foreign technologies. Initially, the call for 
indigenous innovation was more hortatory than real. But recently the 
call has been given practical effect through policies that include not 
only strong incentives for innovation by Chinese companies but also 
policies that discourage the participation of foreign companies in 
technologies or sectors deemed to be strategic by the Chinese 
Government. In a recent survey of 388 U.S. companies conducted by the 
American Chamber of Commerce in China, 28 percent said that they are 
already losing business as a result of China's indigenous innovation 
policies, and 57 percent of high-tech companies said that they expect 
to lose more business in the future as these policies are fully 
implemented.
    Seven of the eight top challenges to doing business in China 
identified by the survey's respondents relate to obstacles posed by the 
policies of the Chinese Government in a wide range of areas, including 
procurement, standard setting, intellectual property protection, 
subsidies and approvals for foreign direct investment. These survey 
results reveal a growing concern among American businesses that China 
is adopting more restrictive promotional policies that favor Chinese 
companies and that pose significant access barriers to foreign 
companies doing business in China. There is mounting evidence that 
China's trade and industrial policies are changing in ways that are 
impeding access of foreign producers to China's market and that fall 
outside of WTO rules and enforcement procedures.
    Preference in government procurement has recently become a key 
weapon in China's arsenal of indigenous innovation policies. According 
to China's long-term plan for scientific and technological development, 
the government should establish a priority procurement policy for 
important high-tech products and equipment developed ``by domestic 
enterprises with independent intellectual property.'' Since China is 
not a signatory to the Government Procurement Agreement (GPA) of the 
WTO, its procurement procedures are not covered by the agreement and 
not actionable at the WTO. But China's preferential treatment of its 
domestic producers in government procurement is not an isolated 
development. Indeed, China's preferential procurement policies were 
given an implicit green light in 2009 when several nations that are GPA 
signatories framed their stimulus actions to provide support to their 
own companies and workers. (The ``Buy America'' provisions of the U.S. 
stimulus package are a case a point. Although these provisions did not 
have a significant effect on procurement and trade in the us, they did 
send a strong signal to China.)
    In November 2009, several of China's most powerful ministries 
issued a joint circular, announcing the intent to create a national 
catalogue of ``indigenous innovation'' products for government 
procurement,`` and proposing accreditation conditions to determine 
whether particular products qualified for inclusion in the catalogue. 
Although the accreditation conditions do not include explicit 
restrictions against the products of foreign-owned companies, they 
effectively deny access to such products if the technology does not 
originate in China--even if the products are entirely produced in 
China, with 100 percent local content. That's because most of the 
products sold by American companies in China embody many technologies 
sourced from the United States and other locations and also because 
American companies are reluctant to develop technologies in China as a 
result of inadequate intellectual property protection there.
    We are encouraged that the recent S&ED discussions made some 
progress on the indigenous innovation and related government 
procurement issues, although China did not agree to a U.S. request for 
full suspension of its indigenous innovation policy. Instead, China 
confirmed its commitment to innovation policies consistent with the 
principles of nondiscrimination, intellectual property protection and 
market competition and agreed to hold high-level bilateral talks on 
such policies. China also agreed that the terms of technology transfer 
should be shaped by agreements among companies without government 
interference. In response to U.S. concerns, China removed several 
troubling conditions from its product accreditation circular, including 
the requirement that products be patented or trademarked in China, and 
agreed to delay final implementation of the national catalogue to 
assess public comments.
    China also promised to submit a revised offer to join the WTO 
Government Procurement Agreement by July. Given the importance of the 
government and of state-owned companies in the Chinese economy, China's 
participation in this agreement should be a major objective of U.S. 
trade policy. As part of its WTO accession agreement, China committed 
that state-owned and state-invested companies would make their 
decisions solely on commercial considerations and that the government 
would not attempt to influence these decisions either directly or 
indirectly. In principle, these commitments are enforceable through the 
WTO dispute settlement mechanism. But U.S. companies frequently 
complain that the procurement decisions of state-owned companies either 
follow the decisions of state agencies or are influenced by government 
actors. A convincing bid by China to join the GPA could help assuage 
these concerns.
    In response to Chinese concerns, the United States softened its 
position on two key issues of longstanding interest to China. First, 
the United States promised to ease restrictions on some high-technology 
exports to China. While this is a priority issue for China, U.S. 
controls on such exports have only a small effect on U.S. trade with 
China. According to recent estimates, only about 0.3 percent of all 
U.S. exports to China and about 0.6 percent of all U.S. advanced 
technology exports to China require an export license. The figures for 
Europe are comparable: 0.2 percent of all U.S. exports and 0.4 percent 
of all U.S. advanced technology exports to the EU require a license. 
Moreover, around 80 percent of the exports to China that require a 
license receive a license exemption and the value of all denied 
licenses is minimal. Second, the United States agreed to consult with 
China on its desire to be accorded ``market economy status'' within the 
WTO and scheduled consultations for the fall meeting of the United 
States-China Joint Commission on Commerce and Trade. In its original 
accession agreement to the WTO, China agreed to be treated as a 
nonmarket economy in antidumping and countervailing duty cases. As a 
result, the United States or any other WTO member can initiate an 
antidumping investigation against Chinese products using the product 
prices of a third country as a benchmark. This makes Chinese firms 
especially vulnerable to antidumping cases and the imposition of 
antidumping tariffs on its products. As part of its WTO accession, 
China also agreed to annual compliances reviews of its implementation 
of its accession agreement.
    So far, the United States has been reluctant to recognize China's 
status as a market economy and has posed several conditions that China 
must meet including the adoption of a market-based exchange rate 
regime. Now the United States will have to decide whether China's 
decision to allow the market to determine the RMB-dollar rate within a 
managed band satisfies this condition. We think it should and we think 
it sets the grounds for progress on China's bid for market access 
status during the upcoming JCCT consultations. The United States will 
lose its ability to use the market access issue as a bargaining chip 
with China in 2016 when it will be accorded such status automatically.
    Both the United States and China have been major beneficiaries of 
the growth in world trade and foreign direct investment triggered by 
the WTO and both have been active users of WTO enforcement to address 
trade disputes, including bilateral disputes. In recent testimony, Alan 
Wolff, cochair of Dewey & LeBoeufs International Trade Practice Group, 
examined the history of United States-China trade relations within the 
WTO and concluded that the United States has enjoyed ``reasonably 
positive results.'' The United States has brought WTO cases against 
China when the U.S. Government has the support of the relevant 
businesses or industries and when it believes it can persuade a WTO 
panel that China is violating its WTO obligations. China has often 
ceased the practices in question without going through a formal dispute 
settlement panel process.
    But the future is likely to be more challenging because many of the 
practices at the center of United States-China trade frictions and many 
of the promotional policies playing a more prominent role in China's 
development strategy are either inadequately covered or are difficult 
to enforce by the WTO. These practices include indigenous innovation 
policies, discriminatory procurement behavior by state-owned 
enterprises, national standards that favor national champions, lax 
enforcement of intellectual property protection and implicit or 
explicit local content rules for participating in major economic 
sectors like wind and other renewable energies. Such practices are a 
violation of the spirit and in some instances the law of China's WTO 
commitments and harm not just U.S. companies but companies from other 
developed and emerging market nations. That's why the United States 
should continue to treat market access barriers as a priority issue in 
the S&ED discussions, should continue to lodge WTO cases against such 
barriers when they violate China's WTO commitments, and should 
encourage China's other trading partners to address such barriers in 
regional and multilateral discussions.

  III. CHINA'S HOLDINGS OF UNITED STATES DEBT AND UNITED STATES-CHINA 
                               RELATIONS

    As of April 2009, China's held over US$2.4 trillion in foreign 
exchange reserves, by far the largest in the world. Its holdings of 
U.S. Treasury debt totaled $900 billion, or about 11 percent of total 
UST debt held by the public and about 25 percent of total UST debt held 
by foreign investors. (China also holds around $405 billion or about 6 
percent of U.S. agency debt, primarily Fannie Mae and Freddie Mac 
debt). At current trends, even with continued rebalancing in China and 
smaller current account surpluses as a share of GDP, China's FX 
reserves will continue to grow, albeit at a slower pace, and are likely 
to top $3 trillion by 2011. Given the lack of attractive nondollar 
currency alternatives, exacerbated by the uncertainty and turbulence in 
euro-denominated assets, it is likely that a significant share of 
China's growing reserves will continue to be held in U.S. Government 
securities. And even if there is a sustained increase in U.S. private 
saving and a significant reduction in the federal budget deficit--both 
of which are far from certain--it is highly likely that the United 
States will continue to run a significant current account deficit in 
the 3-percent to 4-percent range and will continue to depend on foreign 
investors, including China, to finance its saving gap. Moreover, given 
the sheer size of China's holdings of U.S. dollars and government 
securities, a precipitous action by China to shift out of U.S. dollar 
assets could cause a sizeable increase in long-term interest rates in 
the United States, and a sharp decline in the prices of U.S. Government 
securities and the dollar's value. Even cutting the share of China's 
holdings of U.S. Treasury securities by 5-percentage points would 
probably be enough to rock global financial markets, with damage on 
both the United States and China. China would sustain capital losses on 
its large dollar holdings as a result of falling prices on U.S. 
Government securities and a drop in the dollar's value.
    Despite the prospect of such capital losses, would China be willing 
to sell some of its dollar holdings to respond to a foreign policy 
dispute with the United States or to retaliate against what it deemed 
to be an assault on its sovereignty? For example, if the United States 
enacted broad-based trade sanctions on China's exports because China 
does not succumb to U.S. pressure for a sizeable RMB appreciation, 
would China retaliate by selling some of its stock of U.S. Government 
assets or reducing its future purchases of such assets? Many observers 
believe that China would not take such actions, at least not on a 
meaningful scale, because they would impose painful capital losses on 
China. Even if such losses were significant, however, China might be 
willing to bear them in retaliation for what it perceives to be unfair 
trade or other policy sanctions that infringe on its sovereignty. There 
is every reason to believe that China would view such U.S. actions as 
an act of economic aggression. Nationalist sentiment inside of China is 
very high--suggesting that Beijing would be under considerable pressure 
to take retaliatory measures irrespective of any potential portfolio 
losses. There is far more to China's FX management objectives than 
simply seeking optimal rates of financial return.
    Moreover, as Professor Eswar Prasad explained in recent testimony 
before the United States-China Economic and Security Review Commission, 
the potential for losses in the value of China's foreign exchange 
reserves could prove to be quite modest for three reasons:
    1. A spike in U.S. interest rates in response to a selloff of U.S. 
assets by China would impose a capital loss on the value of China's 
U.S. Treasury holdings on a mark to market basis. But given its large 
stock of reserves and the fact that it has no obvious liquidity needs, 
it is likely that China values its assets on a hold to maturity 
approach rather than a mark to market approach.
    2. A decline in the value of the dollar against other major 
currencies triggered by China's action would reduce the RMB value of 
China's dollar-denominated holdings, if the RMB appreciated relative to 
the dollar. Otherwise, China would suffer capital losses on the value 
of its euro and yen assets as the dollar declined, but it would benefit 
from enhanced competitiveness if the RMB declined with the dollar 
against the currencies of its other major trading partners.
    3. A sizeable appreciation of the RMB against the dollar would lead 
to a sizeable capital loss on the value of China's dollar holdings 
measured in local currency. But the loss could be offset over time as 
China moves forward on exchange rate flexibility, capital market 
liberalization, and reserve currency status.
    Prasad concludes that a threat by China to move away from U.S. 
Treasuries is a credible threat that should be taken seriously by U.S. 
policymakers. We agree. And under current market conditions, such a 
threat could trigger investor concern about the huge financing needs of 
the U.S. Government, causing a sharp spike in interest rates and a 
crisis of confidence in U.S. sovereign debt.
    China has repeatedly expressed its desire for FX portfolio 
diversification--namely, to put in place a disciplined program to 
reduce its existing holdings of U.S. Government securities and to slow 
down the acquisition of new holdings. It has been attempting to do this 
in part through the establishment of the China Investment Corporation, 
a sovereign wealth fund with an initial capital base of $200 billion. 
But this is a small amount relative to China's overall dollar holdings. 
The real problem for China is that there are no relatively safe 
investments other than U.S. Government bonds that are deep and liquid 
enough to absorb a significant share of the massive inflow of dollars 
that enter China each year as a result of its large trade surplus, 
inward foreign direct investment and hot money in anticipation of a 
significant RMB appreciation. And the dollar-recycling strategy is, of 
course, heavily dependent on Beijing's desire to maintain a relatively 
tight relationship between the RMB and the dollar. Overall, that means 
that China is likely to continue to hold large amounts of dollar assets 
and that these holdings will grow each year by a sizeable amount.

                          IV. RECOMMENDATIONS

    The S&ED is an important forum through which the United States and 
China can ameliorate the tensions in their relationship and cooperate 
on policies to foster a balanced and prosperous world economy.
    The United States should continue to cooperate with China in the 
G20 on macroeconomic policies to support a strong global recovery and 
to foster more balanced global growth in the future.
    China's stimulus policies fostered a strong rebound of the Chinese 
economy and boosted global growth by providing strong demand for 
exports from the United States and China's other trading partners in 
2009 and through the first half of 2010. China's stimulus policies 
helped rebalance China's growth away from dependence on exports and 
toward domestic demand. In 2009, consumption growth accounted for about 
half of China's GDP growth and China's current account surplus as a 
share of its GDP declined by nearly 50 percent.
    We recommend that China continue to rebalance its future growth in 
order to increase the contribution of consumption and to reduce the 
contribution of exports, and we believe that China will do so out of 
both necessity and choice. The likelihood of slower consumption growth 
in both Europe and the United States over the next several years will 
mean slower growth in the demand for China's exports. To preserve 
social stability, on which the legitimacy of its leadership depends, 
China must boost domestic demand to absorb its growing labor force, to 
move surplus labor from low-productivity agriculture to higher 
productivity manufacturing and services, and to reduce rural-urban 
income gaps.
    We believe that China's infrastructure-led stimulus policies are 
building the foundation for strong future growth in domestic 
consumption. We also recommend and expect that China's upcoming 12th 
Five-Year Plan will spur accelerated proconsumption rebalancing through 
investments in China's social safety net, through policies to promote 
services industries and through tax and other policies to reduce urban-
rural income inequality.
    We believe that as a result of its consumption-led rebalancing, 
China's multilateral trade and current account surpluses will be 
significantly lower as a share of GDP in the future than they were in 
the peak years of 2006-2008.
    China's exchange rate should be assessed from a multilateral 
perspective rather than from a bilateral, dollar-centric perspective.
    We applaud China's June 19 decision to end its crisis-induced RMB-
dollar fixed peg and return to the ``managed float'' foreign exchange 
regime it first adopted in July 2005. A more flexible RMB driven by 
market forces benefits the global economy because it facilitates more 
balanced, sustainable global growth. It is also in China's interest 
because it supports China's rebalancing goals and it allows China to 
pursue a more independent monetary policy. At the same time, a tightly 
managed band on the dollar-RMB exchange rates is an important stability 
anchor for China's transition to more open capital markets. China's 
decision to return to a more flexible currency regime and allow the 
RMB-dollar rate to move within a managed band will allow the RMB to 
appreciate gradually in response to market forces. Over time, a 
stronger RMB will contribute to China's rebalancing by boosting the 
purchasing power of Chinese consumers and by encouraging Chinese 
producers to shift production toward domestic demand and away from 
exports.
    We do not endorse the view that China should make a large 
adjustment in the RMB-dollar rate at this time. The RMB has already 
appreciated significantly in real terms on a multilateral trade-
weighted basis. The key imperative for China is to reduce its saving 
surplus and rebalance its macrostructure. Proconsumption policy 
initiatives will be more important than changes in the RMB's trade-
weighted exchange rate in achieving these goals. The United States 
should refrain from making explicit demands about how China should go 
about implementing its rebalancing agenda. In particular, the choice 
between proconsumption structural adjustments and the RMB-dollar 
exchange rate should be left to China.
    A significant appreciation of the RMB relative to the dollar will 
not have a significant effect on the U.S. trade deficit or on U.S. 
employment. Much of the growth in U.S. imports from China has been the 
result of production moving to lower cost China not from the United 
States but from other higher cost countries, especially in Asia. And 
China's bilateral trade deficit with the United States needs to be seen 
as but one piece of a much broader multilateral problem, reflecting 
America's large saving gap.
    The United States should not impose tariffs on Chinese exports if 
there is not a significant appreciation of the RMB. Such tariffs would 
drive production to other emerging market economies not to the United 
States. In addition, China would retaliate in one of three ways all of 
which would be damaging to U.S. interests: lodging a WTO complaint that 
would almost certainly prove successful; imposing tit-for-tat tariffs 
on U.S. exports to China; or reducing demand for U.S. securities.
    Section 3004 (b) of the Omnibus Trade and Competitiveness Act of 
1988, which requires the Treasury to issue a biannual foreign exchange 
report assessing whether U.S. trading partners are ``manipulating'' 
their exchange rates vis-a-vis the dollar, has become dangerously 
politicized and should be repealed or revised. Currency values should 
be assessed on a multilateral basis rather than a bilateral basis, and 
the International Monetary Fund, rather than the U.S. Treasury, is the 
appropriate multilateral organization for evaluating the exchange rate 
policies of member countries.
    The U.S. current account deficit is the result of the Nation's 
saving gap or the gap between how much the United States is producing 
and how much it is spending. To reduce this gap, the United States must 
reduce the federal budget deficit and, as the economy recovers, must 
increase the household saving rate, which fell to nearly zero during 
the 2001-2007 period. A higher household saving rate will require that 
the United States rebalance growth away from consumption toward 
reliance on exports and investment.
    During the recession, the U.S. saving gap has declined relative to 
GDP, primarily as a result of a sharp temporary increase in private 
saving as households and businesses deleverage. But the saving gap has 
remained substantial as a result of stimulus policies that have caused 
a big increase in ``dissaving'' by the Federal Government. What happens 
to the U.S. current account deficit in the future as the economy 
recovers depends on what the United States does to reduce its saving 
gap. China's trade and exchange rate policies are of second-order 
significance. If the United States fails to reduce this gap, its trade 
and current accounts deficits will rise again as a share of GDP even if 
China succeeds in rebalancing its economy.
    The possibility of an asymmetrical global rebalancing scenario 
remains a very real risk. China's stimulus policies and the likely 
proconsumption thrust of the upcoming 12th Five-Year Plan indicate that 
China should make significant progress in rebalancing its economy over 
the next several years. In contrast, the stimulus policies in the 
United States, although essential and justifiable to offset the 2008-
2009 recession, have exacerbated the long-run saving gap and have not 
rebalanced growth from consumption toward exports and investment. And 
given the partisan atmosphere in Congress, passage of a credible 
multiyear deficit reduction plan to reduce the saving gap on a 
sustained basis once the economy has recovered seems unlikely--at least 
in the near future.
    According to projections by the OMB, the CBO, and private 
forecasters, U.S. fiscal policy is not on a sustainable path: in the 
absence of additional deficit reduction policies, the Federal 
Government's debt will continue to rise relative to GDP through 2020 
even if the economy recovers from the 2008-2009 recession.
    At the S&ED discussions, the United States committed to adopting 
policies to achieve fiscal sustainability in the medium to long run and 
to stabilize the debt-to-GDP ratio. Given the size of projected Federal 
Government deficits, these policies will require some combination of 
painful spending cuts and revenue increases. We recommend that the 
Congress work with the administration to pass a credible multiyear 
deficit reduction plan to stabilize the debt to GDP ratio. This plan 
should take effect gradually as the economy recovers: policies to 
reduce the deficit too quickly will slow the recovery and increase the 
losses in potential output from high unemployment and excess capacity.
    Access to China's large and growing market is a significant factor 
in the success of many U.S. businesses, both large multinational 
companies and many small- and medium-sized companies as well. Reducing 
barriers that impede the access of U.S. companies to China's markets is 
and should continue to be a major objective of U.S. trade policy.
    China's industrial policies appear to be changing in ways that are 
reducing access of foreign producers to China's market and that fall 
outside of WTO rules and enforcement procedures. Indigenous innovation 
policies, discriminatory procurement behavior by state agencies and 
state-owned enterprises, national standards that appear to favor 
national champions, lax enforcement of intellectual property 
protection, and implicit or explicit local content rules in strategic 
activities like renewable energy are areas of growing concern to U.S. 
companies. The United States should continue to negotiate with China to 
reduce these barriers both in the S&ED discussions and in regional and 
multilateral discussions that include China's other trading partners 
who are also disadvantaged by such barriers.
    Given the importance of the government and of state-owned companies 
in the Chinese economy, China's participation in the Government 
Procurement Agreement (GPA) of the WTO should be a major objective of 
U.S. trade policy. The United States should negotiate with China to 
ease U.S. security controls on exports to China and to advance the 
timing for the recognition of China's market economy status in the WTO 
(currently scheduled for 2016) in return for a strong offer by China to 
join the GPA. A bargain along these lines could also help revitalize 
the Doha talks, something the United States and China committed to do 
at the recent S&ED meeting.
    The United States should take the lead in negotiating a Trans-
Pacific Partnership agreement as a major step to the creation of a free 
trade area for the Asia Pacific. Several bilateral and regional 
preferential trading agreements have recently been signed in Asia, and 
the region is heading toward the de facto creation of an economic bloc 
that would be discriminatory against the United States. The completion 
of a Trans-Pacific Partnership agreement would arrest this disturbing 
trend and could re-ignite APEC's role in global trade liberalization. 
In the 1990s, APEC played a key role in the negotiation of a global 
agreement liberalizing trade in information technology products. A 
revitalized APEC could play a similar role in the creation of a global 
agreement on trade in ``green'' technologies and products.
    A threat by China to shift the allocation of its vast foreign 
exchange reserve portfolio away from U.S. securities to respond to a 
foreign policy dispute with the United States or to retaliate against a 
U.S. policy deemed to be an assault on China's sovereignty is a 
credible threat that should be taken seriously. Even the suggestion of 
such a move could trigger concerns among global investors about the 
huge financing needs of the U.S. Government, causing a sharp spike in 
interest rates, a crisis of confidence in U.S. sovereign debt, and a 
collapse in the dollar. As the world's largest external borrower, the 
United States must exercise great caution in exerting undo pressure on 
its most important foreign lender.

References
    Michael Linden and Michael Ettlinger, ``Restoring Fiscal Balance: 
The new Deficit Commission's 2015 Targets, Center for American 
Progress,'' April 26, 2010.
    Eswar Prasad, ``The U.S.-China Economic Relationship: Shifts and 
Twists in the Balance of Power,'' written testimony, hearing on ``U.S. 
Debt to China: Implications and Repercussions,'' U.S.-China Economic 
and Security Review Commission, February 25, 2010.
    Stephen S. Roach, ``Consumer-Led China,'' a paper presented to the 
11th annual China Development Forum, sponsored by the Development 
Research Center of the State Council PRC, held in Beijing on March 20-
22 2010.
    Stephen S. Roach, ``America's China Complex,'' American Review, May 
2010.
    Alan W. Wolff, ``China in the WTO,'' written testimony, hearing on 
``Evaluating China's Role in the World Trade Organization over the Past 
Decade,'' U.S.-China Economic and Security Review Commission, June 9, 
2010.
    Alan W. Wolff, ``The Direction of China's Trade and Industrial 
Policies,'' written testimony, hearing on China's Trade Policies, House 
Ways and Means Committee, June 16, 2010.

    The Chairman. Thank you very much, Dr. Tyson.
    Ambassador Hills.

      STATEMENT OF HON. CARLA A. HILLS, FORMER U.S. TRADE 
 REPRESENTATIVE, CHAIRPERSON, NATIONAL COMMITTEE ON U.S.-CHINA 
                   RELATIONS, WASHINGTON, DC

    Ambassador Hills. First of all, thank you very much, Mr. 
Chairman, Senator Lugar, and the other members of the 
committee. It's a great pleasure to appear again before the 
Senate Foreign Relations Committee.
    I think your focus on the economic issues is absolutely 
indispensable today. I have submitted testimony that responded 
to your seven questions, and I just picked out three issues 
that I thought I would summarize, since I was told 5 minutes 
was the limit. One is trade, one is the imbalance, and, last, 
the Strategic and Economic Dialogue. And I look forward to your 
questions.
    Our Secretary of State has stated, not once but several 
times, that our relationship with China is the most important 
bilateral relationship in the world in this century. And in the 
area of trade, I would say that is already evident.
    Between 2000, the year before China entered the World Trade 
Organization, and 2008, just before the great recession, United 
States sales to China increased 340 percent; whereas, during 
that same period, our sales to the rest of the world increased 
just 29 percent. And, significantly, every State in the Union 
has seen near triple-digit growth of their sales to China. Even 
more significantly, in my opinion, last year, when global trade 
plummeted 11 percent, pulling global growth into negative 
territory, our exports to China held steady, where our exports 
to the rest of the world fell by 20 percent.
    And, as Senator Lugar has pointed out, today China is our 
fastest growing export market, and has become our second-
largest export market, behind Canada. And we both benefit from 
keeping our respective markets open and avoiding all forms of 
protection, such as Buy America legislation and Buy China 
policies.
    And it is in our mutual interest to work further to open 
global markets. As Dr. Gary Hufbauer, of the Peterson Institute 
for International Economics, has calculated, the United States 
economy is $1 trillion richer per year as a result of our 
leadership in opening global markets since World War II, and, 
similarly, it's thanks to open markets that China has achieved 
double-digit growth for the past three decades that has lifted 
hundreds of millions of people out of dire poverty.
    So, going forward, we should boost our global trade and 
with it our respective nations' growth by reaching agreement in 
the Doha Round, and we're more likely to achieve an agreement 
in those negotiations if the United States and China work 
together.
    In addition, while both of our economies are recovering 
from the great recession, neither government can ignore the 
fact that the existing global imbalance risks triggering 
another serious financial crisis. Indeed, the former chairman 
of the New York Fed has stated that, even without the housing 
crisis here in the United States, the global imbalance would 
have eventually led to the crisis that we have suffered.
    Now, China, Germany, Japan, South Korea, and others, have 
built their growth on exports, accumulating substantial 
surplus, whereas the United States, the United Kingdom, and 
Spain, and others, have built their growth on consumption, 
accumulating substantial debt. Neither growth model is 
sustainable. And although the United States has cut its 
external Federal debt from its 6-percent peak in 2006 to about 
3 percent last year, it still remains the world's largest 
debtor nation. And although China has cut its current account 
surplus from its 11-percent peak in 2007 to about 5 percent in 
2009, it still remains the world's largest creditor nation.
    And most thoughtful economists suggest that these declines, 
while welcome, are driven more by cyclical factors than by 
structural factors. And it's the structural factors that both 
nations and their colleagues that find themselves in similar 
circumstance need desperately to address.
    To ensure that we do not suffer again from a financial 
crisis, the global economy simply must be brought into better 
balance. And this is a global problem. But, if the largest 
debtor nation and the largest creditor nation were to lead by 
example and commit to specific structural reforms within 
realistic timeframes, with periodic updates, that would not 
only give confidence--great confidence, in my view--to the 
global market, it would also put our respective economies on a 
sustainable growth path and ensure the future prosperity of our 
respective populations.
    For example, the United States could commit to a plan at a 
G20 meeting--we're having a G20 meeting in a couple of days--to 
bring its primary budget deficit into balance within say 5 
years, and its external deficit into better balance in say 10 
years, setting forth benchmarks to measure its progress, which 
it would report at future G20 meetings.
    Similarly, China could commit to a plan at a G20 meeting to 
stimulate its domestic consumption by gradually correcting the 
underpricing of capital, water, land, and energy that favors 
its state-owned enterprises and heavy industry, that export, 
and permitting interest rates to rise on bank deposits, making 
credit more available to small- and medium-size enterprises, 
and further loosening the controls over its currency, and 
providing progress reports in these areas in future G20 
meetings.
    And the Strategic and Economic Dialogue that was referred 
to in your questions provides, in my view, an extremely 
valuable forum for thinking through the tough issues, like 
rebalancing and protectionism. It brings together Cabinet-level 
officials on both sides to discuss difficult challenges facing 
both nations, like the need for further opening the global 
markets, stimulating innovation, addressing environmental 
issues, and resolving bilateral differences over trade and 
investment. Its value could be enhanced by smaller delegations: 
The last delegation coming from the United States numbered 200, 
and there was an equal number on the Chinese side; it's tough 
to achieve a real personal relationship in a group of 400. And 
more frequent meetings would facilitate the building of the 
personal relationships, which I deem to be extraordinarily 
important and key to building mutual trust.
    There's so much more that I could say, but I notice the 
clock is blinking. And so, let me stop. And I am pleased to 
take your questions.
    [The prepared statement of Ambassador Hills follows:]

  Prepared Statement of Hon. Carla A. Hills, Chair and CEO of Hills & 
           Company, International Consultants, Washington, DC

    Mr. Chairman and members of the committee, thank you for inviting 
me to share with you my views regarding opportunities and challenges in 
the United States-China Economic Relationship. You have posed seven 
questions.

I. WHAT ARE THE KEY ISSUES FOR THE UNITED STATES AND CHINA POLICYMAKERS 
   TO CONSIDER REGARDING FAIR AND OPEN ACCESS TO EACH OTHER'S MARKET?

1. Keeping Bilateral and Global Markets Open
    The most important issue for leaders in the United States and in 
China to keep firmly in mind is that their nation's prosperity requires 
keeping bilateral and global markets open. History shows that no 
country has done well by sealing itself off from the world.
    Economist Dr. Gary Hufbauer in a comprehensive study published by 
the Peterson Institute for International Economics calculates that the 
opening of global markets since World War II has increased our nation's 
GDP by roughly $1 trillion per year, thus raising the average American 
household yearly income by $9,500. He further calculates that the 
additional opening of world markets to trade and investment could 
increase U.S. wealth potentially by another $500 billion per year, 
making the average American household richer by an added $4,500 per 
year. It is hard to think of another economic policy decision that 
could have such a positive impact on U.S. economic well-being.
    And it is thanks to the opening of global markets that China has 
averaged double digit growth over the past three decades, enabling it 
to lift hundreds of millions of people out of dire poverty. Today, 
China has become the world's fastest growing major economy. This year 
it is likely to replace Japan as the world's second-largest economy.
    The benefits of open markets are enormous. The prosperity of the 
peoples of both China and the United States will be enhanced by 
maintaining a strong and vibrant economic relationship.
    Yet economic hardship inevitably stokes economic nationalism. Last 
year for the first time since World War II, global trade plummeted 11 
percent and global output fell into negative territory. Americans were 
hit by historic job losses, home foreclosures, and bankruptcies. China 
did not escape the crisis. It was forced to shutter hundreds of 
assembly and manufacturing facilities putting millions of people out of 
work.
    Although the International Monetary Fund forecasts world output 
will grow by more than 4 percent this year and global trade will 
increase by 7 percent, there is considerable pain remaining. 
Policymakers in the United States and in China will expedite the 
economic recovery that is now underway by resisting calls to impose 
market barriers on the trade or investment of the other.
    In spite of our different histories, form of governments, and 
domestic sensitivities, an important fact for both Chinese and American 
policymakers to keep in mind is the enormous potential for extremely 
positive interaction between the largest and the fastest growing 
economies.
2. Rebalancing Our Economies
    While both of our economies are recovering, our policymakers cannot 
ignore the fact that the imbalance that exists in our respective 
economies could trigger another crisis. In the last half decade China 
has become the world's largest creditor nation, and the United States 
its largest debtor nation. Although China has cut its surplus from its 
peak in 2007 of 11 percent of its GDP to about 5 percent in 2009 and 
3.5 percent in the first quarter of 2010, and the United States 
external federal deficit has come down about from its peak in 2006 of 6 
percent of GDP to 2.8 percent in 2009, thoughtful economists who have 
studied this issue believe that both declines were largely driven by 
cyclical factors and that structural changes are still required if we 
are to protect against future global financial crises.
    The United States will need to reduce both its primary budget 
deficit and its external deficit. China will need to reduce its 
reliance on exports and heavy industry. Although the action that each 
government takes to restructure its economy is independent of the 
other, it is an issue that both policymakers must address.

  II. WHAT POTENTIAL DOES THE CHINESE MARKET HOLD FOR U.S. COMPANIES?

    The actual and potential of the Chinese market is substantial and 
growing. China has become America's third-largest export market behind 
Canada and Mexico and is our fastest growing export market. Between 
2000, the year before China joined the World Trade Organization (WTO) 
and 2008, U.S. sales to China increased 340 percent whereas U.S. sales 
over that same period to the rest of the world increased just 29 
percent.
    Importantly, virtually every state in the union has seen near 
triple digit increases in its sales to China. Last year computers and 
electronics, crop production, chemicals and transportation equipment 
comprised our top four exports to China. These are all sectors that 
generate good domestic jobs.
    And in 2009 when for the first time since WWII trade plummeted 11 
percent dragging world growth into negative territory, U.S. exports to 
China held steady whereas U.S. exports to the rest of the world fell 
nearly 20 percent. This year through April, U.S. exports to China are 
up 42 percent and are 17 percent higher than the comparable period in 
2008.
    It is not surprising that U.S. companies continue to seek to do 
business in and with China. In 2009 in spite of the economic crisis 
that adversely affected both China and the United States, the value of 
U.S. goods exported to China was about $70 billion roughly the same 
amount as before the crisis, and if sales of U.S. goods to Hong Kong 
are added, the total climbs past $90 billion. In addition, U.S. exports 
of services to China topped $15 billion. And sales of U.S. affiliates 
in China topped $84 billion in 2007 before the crisis and the latest 
year for these statistics. In short, the U.S. current market in China 
exceeds $100 billion and that market is steadily growing.

  III. WHAT ARE THE CHIEF OBSTACLES THAT U.S. COMPANIES FACE IN CHINA?

    Foreign companies face a number of obstacles in doing business in 
China. There are voices in the Chinese leadership, as there are here in 
the United States and elsewhere, urging the adoption of restrictive 
measures to protect specific interests of domestic businesses. Measures 
in China that have been particularly nettlesome to U.S. companies 
include:
1. Government Procurement: ``Indigenous Innovation'' Policy
    In 2006, China, in an effort to produce ``national champions,'' 
adopted an ``Indigenous Innovation'' policy that sought to encourage 
government purchases of domestic products in specific sectors. Last 
year the government produced lists of favored products. As a result of 
bilateral dialogues, the government has moved from mandating domestic 
purchases to encouraging them. However this ``buy China'' policy is a 
major concern to U.S. entrepreneurs, particularly those in the high 
technology sectors.
2. Protection of Intellectual Property
    According to a survey conducted by the United States-China Business 
Council, two-thirds of U.S. companies found China's failure to protect 
adequately intellectual property adversely affected their businesses in 
China. Getting the legal structure right is important. In 2009, the 
United States brought and won a case in the WTO dealing with copyright 
infringement which resulted in China amending its laws. However, 
enforcement is a major problem at the central, provincial and local 
levels.
3. Standards and Testing
    U.S. companies are adversely impacted by standards that are drafted 
to favor Chinese domestic products. For example, an ingredient that is 
harmless may be prohibited in a particular product when that ingredient 
is not used in competing Chinese products.
    U.S. companies find China's testing process challenging. A Chinese 
certification board is responsible for testing most products sold in 
China. That top-down approach is different from the process used in the 
United States where industry develops the product standards in the 
first instance.
4. Investment Restrictions
    A United States-China Business Council survey of its member 
companies doing business in China indicates that roughly 90 percent of 
its member companies invest in China to reach the market there, not to 
export back to the United States. Although some sectors are open, 
others including chemicals, automobiles, telecommunications and express 
delivery encounter some restrictions. China is in the process of 
revising its 2007 Catalogue Guiding Foreign Investment in Industry.

IV. HOW CAN THE UNITED STATES BEST STRENGTHEN ITS TRADE AND INVESTMENT 
TIES WHILE ENSURING U.S. COMPETITIVENESS IN AN INCREASINGLY COMPETITIVE 
                              ENVIRONMENT?

    Our Nation can strengthen its trade and investment ties with the 
trading nations of the world including China in a number of ways 
including (1) leading the 153 members of the World Trade Organization 
(WTO) to a successful conclusion of the Doha Round of Multilateral 
Negotiations; (2) expanding efforts to open markets with the 21 
economies comprising the Asia Pacific Economic Cooperation forum (APEC) 
starting with completing the Trans-Pacific Partnership; (3) approving 
the three pending free trade agreements that have been signed with 
South Korea, Colombia, and Panama; (4) completing the negotiation of a 
Bilateral Investment Treaty with China; and (5) addressing our 
restrictions on immigration that reduce our competitiveness.
1. Doha
    For six decades the United States under both Democratic and 
Republican administrations led the world in opening global markets to 
trade and investment with the result that economic growth both globally 
and nationally soared for rich and poor nations alike. Our actions in 
the early multilateral negotiations under the General Agreement on 
Tariffs and Trade (GATT) accelerated the economic rebuilding of nations 
devastated by World War II. Today we could be equally far sighted by 
achieving an agreement in the Doha Round of Multilateral Negotiations 
that would integrate developing nations more solidly into the global 
trade regime and in so doing enlarge trade and investment opportunities 
that would fuel economic growth at home and around the world. 
Unfortunately, we are no longer leading efforts to open global markets.
    Currently in its ranking of 133 trading nations, the World Economic 
Forum ranks the United States behind 43 nations in terms of how open 
the domestic market is to trade. However, the Doha Round offers our 
Nation an outstanding opportunity to do well by doing good. One example 
stands out. By agreeing to reduce meaningfully our agricultural 
subsidies, we could persuade other governments with high subsidies to 
do the same. Opening global agricultural markets would not only benefit 
our farm exporters, but it would show the world that we are serious 
about taking steps to put our Nation on more a more sustainable fiscal 
path.
2. APEC and TPP
    Expanding our trade and investment ties in Asia offers the United 
States a significant opportunity to stimulate domestic economic growth 
and job creation. The 21 members of the Asia Pacific Economic 
Cooperation forum (APEC) represent approximately 2.5 billion consumers, 
58 percent of global trade, and more than half of world output. Over 
the past decade most of the increase in global growth has been 
generated by the APEC economies. Collectively these economies account 
for a majority of our Nation's exports. Further opening these markets 
to U.S. entrepreneurs would enhance our Nation's competitiveness in the 
world's most vibrant region where other major trading nations including 
China, Japan, South Korea, the European Union and the economies 
comprising the Association of Southeast Asian Nations (ASEAN) have 
negotiated or are currently negotiating bilateral and plurilateral 
trade agreements that advantage their entrepreneurs over ours. 
Obtaining equal or better access to these markets would enhance our 
Nation's competitiveness, create jobs, and boost growth.
    Achieving this will require leadership and action on our part. To 
strengthen our trade and investment ties in this high-growth region, we 
should move forward promptly to negotiate the Trans-Pacific Partnership 
(TPP),\1\ which could serve as a first step toward a broad market 
opening agreement in the region which over time could incorporate 
additional APEC members, such as Japan, South Korea, Indonesia, 
Malaysia, and eventually China. Such an agreement would not only 
enhance our Nation's competitive position, it would also create a 
visible bond across the Pacific to work against the world splintering 
into three blocs (Asia, Europe, and the Americas) which would both 
impede global and national economic growth and increase the potential 
for global instability. The APEC summit in Hawaii in 2011 gives the 
United States an excellent opportunity to showcase a completed TPP, 
which would demonstrate its renewed commitment to the region.
---------------------------------------------------------------------------
    \1\ Currently involving Australia, Brunei, Chile, New Zealand, 
Peru, Singapore, the United States and Vietnam.
---------------------------------------------------------------------------
3. Approval of Pending Free Trade Agreements
            A. Korea Free Trade Agreement
    Approval of the Korean Free Trade Agreement would both enhance our 
competitiveness in Asia and demonstrate our continued interest in the 
region. Under its terms South Korea, currently our seventh-largest 
trading partner, would open its market to U.S. farm products, goods, 
and services, enhance its protection of intellectual property and 
substantially open government procurement. Ninety-five percent of 
bilateral trade in consumer and industrial products would become duty 
free within 3 years. The agreement would cause trade to expand between 
our two nations and stimulate both economic growth and jobs in both 
markets and put our entrepreneurs on an equal footing with the growing 
list of major trading nations that have already negotiated trade 
agreements with South Korea.\2\ Significantly, it has indicated an 
interest in negotiating a trade agreement with China, which if 
concluded, would put our exporters at a substantial disadvantage in one 
of our key export markets.
---------------------------------------------------------------------------
    \2\ Korea currently has five free trade agreements in effect, two 
that are signed and pending ratification, negotiations underway with 
eight other countries and is considering entering negotiations with six 
more.
---------------------------------------------------------------------------
            B. Colombia and Panama Free Trade Agreements
    Approval of the trade agreements that the United States has signed 
but not ratified with Colombia and Panama would substantially enhance 
our competitiveness in Latin America. Colombia with its $250 billion 
economy is the second-largest in South America. Today in excess of 90 
percent of U.S. imports from Colombia enter the United States duty free 
while relatively high tariffs are imposed on most U.S. exports. The 
agreement would eliminate 80 percent of those tariffs and open up 
markets to a broad range of services and investment. That would make 
exports more competitive and remove the additional disadvantage our 
exporters face not only by ``leveling the playing field'' between the 
two countries but also by achieving equality with Colombia's other 
trading partners like Canada that have already entered a free trade 
agreement with Colombia.
    Similarly opening Panama's market would make our goods, services, 
and investment more competitive. It makes no sense for us to be the 
impediment that enables Panama to ship its products duty free and to 
assess duties on our services and goods including our competitive heavy 
equipment used for canal upgrades when much of our competition ships 
duty free.
4. Bilateral Investment Treaty With China
    As economist Dr. Hufbauer has ably documented U.S. outward foreign 
investment pulls U.S. exports into the foreign market, while inward 
foreign investment into the United States boosts economic growth and 
creates domestic jobs. To establish clear rules governing inward 
investment gives certainty to the market and confidence to investors, 
plus it helps to avoid controversy. In June 2008 at the fourth 
Strategic Economic Dialogue, China and the United States agreed to 
begin negotiations of a bilateral investment treaty to protect the 
interests of their respective investors in the other's economy. Such an 
agreement would protect our investors against discriminatory measures 
that today account for a major portion of the obstacles that confront 
our businesses in China. With economic nationalism on the rise in both 
countries, moving ahead to conclude an investment treaty would enhance 
U.S. competitiveness by insuring that we can capture the growth and 
jobs that attend cross border investment.
5. Immigration Contributes to U.S. Competitiveness
    We usually talk of trade ties in terms of goods, services, and 
investment and less frequently mention people and ideas. Yet the United 
States is a nation of immigrants. Talented people from all over the 
world come to work or study in the United States bringing their ideas, 
starting businesses, creating jobs and contributing to our 
competitiveness. According to a study published in 2008 by the Small 
Business Administration,\3\ immigrants constitute 12.5 percent of U.S. 
businessowners and start 25 percent of new engineering and technology 
companies. Another study published in 2009 by the American Electronics 
Association,\4\ found that immigrants were CEOs or lead technologists 
in one of four technology and engineering companies started in the 
United States between 1995 and 2005. These immigrant-founded companies 
employed 450,000 workers and generated $52 billion in revenues in 2006. 
Unfortunately for our economic growth, creation of new jobs, and 
overall competitiveness the annual number of H-1B visas is sharply 
restricted. Current law limits H-1B visas to 65,000 annually with up to 
20,000 available for foreign nationals holding advanced degrees from an 
American university. America could boost its growth, job creation, and 
competitiveness by opening its doors more widely to talent from beyond 
its border.
---------------------------------------------------------------------------
    \3\ Robert W. Fairlie ``Estimating the Contribution of Immigrant 
Business Owners to the U.S. Economy,'' Small Business Administration 
Office of Advocacy, November 2008, http://www.sha.gov/advo/research/
rs334tot.pdf.
    \4\ ``Workforce & Immigration Overview: Maintaining a High-Skilled 
U.S. Technology Workforce,'' 2009, http://www.acanet.org/
GovernmentAffairs/gaet_1B_HIBVisa.asp.
---------------------------------------------------------------------------

   V. THE STRATEGIC AND ECONOMIC DIALOGUE IS OUR BILATERAL FORUM FOR 
      ENGAGEMENT ON MANY OF THESE ISSUES. HOW WOULD YOU RATE THE 
                     EFFECTIVENESS ON THESE ISSUES?

    I believe that the Strategic and Economic Dialogue is an important 
bilateral forum that can help our government to build a solid 
relationship with the world's fastest growing economy. It provides the 
opportunity for our leaders at the highest level to meet their 
counterparts and discuss critical issues. These discussions can enhance 
our understanding of China's economic challenges as well as its 
strategic objectives and ensure that China's leaders understand ours. 
Mutual understanding is indispensable to finding solutions to tough 
issues. The list of economic issues that require collaboration for 
proper resolution is long and growing including rebalancing our 
national and the global economies, energy security, trade policy, 
financial reform, and environmental protection. To address effectively 
these and other issues, it is overwhelmingly in our national interest 
to maintain a close, candid, and collaborative relationship at the 
highest levels, and the Strategic and Economic Dialogues help to do 
just that.
    We know that high-level engagement works. In recent years our 
Deputy Secretary of State met frequently to discuss issues of foreign 
policy. In addition our Secretary of the Treasury led the effort called 
the Strategic Economic Dialogue (SED) whereby Cabinet-level officials 
from both governments met to discuss economic issues for 2 days twice a 
year. The purpose of the SED was to discuss complex, longstanding, 
economic challenges and to craft solutions satisfactory to both 
governments.
    Since both our governments are quite compartmentalized and have 
different organizational structures, these meetings helped to 
circumvent the stovepipe structures that impede decisions by bringing 
to the table all the high-level officials on both sides required for a 
decision.
    These face-to-face meetings enabled both sides to understand the 
concerns of their counterparts and led to a number of positive 
outcomes. For example in 2007 when food and safety issues were very 
much in the news, high-level officials from both governments seriously 
discussed at an SED meeting effective ways to deal with these issues.
    At the next meeting of the SED, representatives of our Food and 
Drug Administration and our Consumer Products Safety Commission and 
their Chinese counterparts were able to announce a Memorandum of 
Understanding covering how they would cooperate in food and safety 
investigations. Representatives of our FDA have publicly stated that 
they had never before enjoyed such a high level of positive interaction 
with their counterparts in China. They have established offices in 
Beijing, Guangzhou, and Shanghai.
    More recently at the S&ED meeting this past May, after discussion 
the Chinese Government agreed to submit a proposal to join the WTO 
Government Procurement Agreement by the end of July. Such an agreement 
would protect our entrepreneurs against some of the discrimination that 
they name as the top obstacle they encounter today in penetrating the 
Chinese market.
    The economic dialogues not only provided an effective forum for 
raising and solving economic issues of concern to both our governments, 
but they also created a mechanism that avoids having to initiate talks 
among strangers in the heat of a crisis.
    Accordingly I was very pleased when it was announced that our 
Secretaries of State and Treasury would share leadership of a high-
level bilateral dialogue, now called the Strategic and Economic 
Dialogue. The S&ED first met in July last year and again last month for 
2 days on each occasion. The plan is to hold these meetings on an 
annual basis dedicating one day to a plenary session and the second day 
to separate discussions on economic and strategic issues.
    The one downside that I see in the new structure is its sheer size. 
In May our delegation to Beijing comprised 200 senior officials, the 
largest U.S. delegation to China in the history of our bilateral 
relationship. The merged strategic and the economic groups bring 
together such a large number of participants that relationship-building 
that has been so helpful in the past will be far more difficult.
    Another downside I see is that the stated intention is to meet 
yearly rather than twice each year. Formerly, two full days twice a 
year, four days total, were devoted to economic discussions. Now only 
one day each year will be devoted exclusively to economic issues. Our 
bilateral economic agenda is long and growing longer which suggests to 
me the need for more rather than fewer meetings.
    There are two other bilateral dialogues that provide valuable means 
to have sustained focus on critical economic issues, but they are not 
conducted at the same high level. One is the Joint Commission on 
Commerce and Trade, a senior officials group that has formed some 17 
working groups to address specific issues including industrial and 
competition policy, intellectual property, information technology, and 
trade and industry. Most of these plan to meet twice a year.
    The second is the United States-China Investment Forum, a deputies 
led group that is focused on such issues as procurement, standards, and 
access to markets for services.

   VI. CAN WE MAXIMIZE OUR ABILITY TO ADDRESS CONCERNS ABOUT CERTAIN 
  CHINESE ECONOMIC POLICIES THROUGH MULTILATERAL FORA SUCH AS THE G20?

    The G20 group of nations representing the world's 20 largest 
economies which has replaced the G8 representing the eight large 
industrialized nations is far better equipped to deal with today's 
global economic challenges.
    Three issues of key importance to both the United States and China 
are better suited to the G20 forum than bilateral discussion: (1) 
China's currency regime; (2) the need to rebalance the global economy; 
and (3) the need to keep global markets open in the face of domestic 
calls for protectionism.
I. China's Currency Regime
    China's currency controls have been an issue of contention not only 
with the United States, but also with the European Union, which is 
China's largest trading partner, as well as a number of other nations. 
China's announcement a few days ago that it will permit the yuan to 
gradually appreciate will help to reduce those tensions. Monitoring 
this issue at future G20 meetings will be helpful in that it will 
maximize pressure on China which wants to be seen as constructive in 
international fora and minimizes bilateral contention.
2. Rebalancing the Global Economy
    The global recovery that is currently underway, faster for some 
than for others, could be derailed by the serious imbalance of the 
global economy that has ballooned in recent years. China, Germany, 
Japan, South Korea, and other Asian economies have built their growth 
on exports, whereas the United States, the United Kingdom, and Spain 
among others have relied excessively on domestic consumption, 
particularly in the housing sector, to fuel economic growth.
    Although investment excesses by the financial sector triggered the 
fiscal crisis in 2008, there is general agreement that the global 
imbalance made the crisis much worse. As stated last year by Gerald 
Corrigan, former President of the New York Federal Reserve: ``It is 
highly likely that these imbalances would create a serious 
macroeconomic problem even if we had not had the fiscal problem.''
    If we are to protect against future global financial crises, the 
global economy must be brought into better balance. That will require 
debtor and creditor nations to alter their existing economic models to 
put their economies on a more sustainable growth plan. Debtor nations 
cannot continue to consume at the excessive levels of the past, and 
creditor nations must look more to their own consumers to fuel their 
economic growth.
    This is a global problem and requires a global solution. However, 
global balance is more likely to be restored if the world's largest 
debtor nation and its largest creditor nation were to lead by example 
with each committing to specific structural reforms, spelling out the 
steps that each would take within specific timeframes, and agreeing to 
provide periodic updates regarding progress. That would boost 
confidence in the future health and stability of the global market, 
which in turn would help keep our respective domestic economies on a 
sustainable growth path.
    The required changes will take time to implement. But a plan of 
action over a period of years could be announced that would give 
confidence to the market and to investors. One could imagine the United 
States announcing a plan at a G20 meeting to bring its primary budget 
deficit into balance within a specified period like 5 years and its 
external deficit into balance in a specified period like 10 years and 
to report regularly at future G20 meetings on its progress.
    Similarly, one could imagine China announcing at a G20 meeting a 
plan to stimulate its domestic consumption by correcting its 
underpricing of capital, water, land, and energy to large enterprises, 
permitting interest rates to rise on bank deposits, making credit more 
available to small- and medium-size businesses, and continuing the 
steady and gradual loosening of controls on the yuan that it announced 
this past weekend with progress reports on these structural changes at 
future G20 meetings.
    Such a commitment by the United States to undertake structural 
reform necessary to achieve more balanced growth would not be a favor 
granted to nor conditioned on action by China, nor would a decision by 
China to make structural changes to stimulate domestic consumption be a 
favor granted to or conditioned on action by the United States.
    The policy corrections that each needs to make are necessary to 
ensure each nation's future financial stability and prosperity, for if 
corrections are not made the global imbalance will likely ignite 
another economic crisis. By their respective actions, they would not 
only give confidence to the market but also help persuade other nations 
with imbalances to follow their lead. The G20 provides an appropriate 
forum.
3. Keeping Global Markets Open
    Leaders of the G20 nations which account for 85 percent of world 
output and 80 percent of world trade have taken a leadership role with 
respect to the global economy. They meet biannually to consult and 
collaborate on critical global economic issues.
    The G20 leaders instead of simply pledging support could take 
action and make history by bringing the Doha Round to a successful 
conclusion. Economic studies document that the reductions in trade 
barriers that could be secured in this round of trade talks would boost 
world output between $300 billion and $700 billion a year. We need that 
growth now.

   VII. WHAT ARE YOUR BROAD VIEWS ON THE IMPORTANCE OF THE ECONOMIC 
        RELATIONSHIP AS PART OF A LARGER FOREIGN POLICY AGENDA?

    There is no question but that a collaborative, constructive 
economic relationship creates a positive environment for discussing 
tough and contentious foreign policy issues. Even where national 
interests on foreign challenges diverge, a solid economic relationship 
makes serious discussion of and possible narrowing of those differences 
more likely.
    That does not mean that we should forgo pressing our economic 
interests. From time to time we will have economic differences with our 
large and important trading partners, including China. When we believe 
that China or any trading partner has violated recognized rules of the 
WTO, or the rules of other international agreements, we should act and 
use the dispute settlement mechanisms provided to resolve the problem. 
And where the rules of the system are insufficient, we should negotiate 
to ensure that they reflect market realities.
    Our government has taken China to the WTO eight times. We have 
settled four of the cases, won three and have one pending. China has 
brought five cases against us. We have settled one, won two, and lost 
two.
    This is how the WTO trade regime should work. It enables us to 
resolve trade issues under mutually agreed transparent rules minimizing 
friction.

                               CONCLUSION

    Managing United States-China relations presents challenges but also 
very substantial opportunities. Many in America ask: Can the world's 
largest and fastest growing economies constructively work together to 
enhance our future prosperity and stability? Or have the differences 
between our increasingly competitive economies along with those 
differences in our histories, forms of government, and domestic 
sensitivities become too great to enable us to harness our respective 
strengths to deal effectively with today's bilateral and global 
challenges?
    My answer is that we can, should, and must work constructively 
together. Most importantly, I believe that by doing so we can build 
habits of cooperation that will help us deal effectively with new 
challenges as they arise which will not only enhance the well-being of 
the people of the United States and of China but will contribute 
meaningfully to global peace and stability.

    The Chairman. Well, Ambassador Hills, Dr. Tyson, thank you 
very much. You've put a lot of food for thought on the table, 
and I want to pick up in a few places right away.
    Ambassador, you just mentioned that China's open markets 
have resulted in the double-digit growth. A lot of people would 
argue about how open that market really is; sort of a one-way 
street, in some people's opinion.
    I was over there recently, meeting with a bunch of our 
companies, all of whom complained about the Chinese Government 
bidding process and procurement process, and how really 
impossible it was for them. You know, they'd bid, they'd do 
well, but they never got chosen. It was always a domestic 
company or a majority-owned company. It's always, you know, 
China-centric.
    Now, that works very effectively for them, obviously. And 
with the kind of growth that they've had and the opportunities 
they've had, a lot of people are willing to, you know, put 
their money down and go for it.
    But, it's not creating the kind of--I mean, the single 
biggest effect on this question of the current accounts 
deficit--on our current accounts deficit while we've gone up 
the 300 percent as you've mentioned, it's nowhere near where it 
ought to be, nor is their consumption commitment where it ought 
to be.
    So, I mean given the clear penchant for the Chinese to kind 
of do what they want, when they want, which is what they've 
done on the renminbi, the reevaluation--way late, not enough, 
in some people's view--so, it's sort of an incremental deal, 
which won't have the kind of impact it ought to.
    So, help us understand, if you would, is there any 
leverage? Do you have any leverage with your banker--your 
biggest banker? Do we have any ability to do anything except 
ask and hope?
    Ambassador Hills. Well, first of all----
    The Chairman. It's not a new topic. We've been going 
through this through several administrations, and it's not 
getting better, it's getting worse.
    Ambassador Hills. Mr. Chairman, I would say that our trade 
with China over the last decade has soared. The figures that I 
gave you, of a 340-percent increase and China becoming this 
year our second-largest export market, is really remarkable for 
a country that, in 1978, was a Communist country, sealed off 
from the rest of the world. It's remarkable progress in three 
decades.
    And if you look at where our trade deficit has gone, in 
1998 the composition of our trade deficit--it was 75 percent in 
East Asia; today, it is 49 percent in East Asia and 51 percent 
with the rest of the world. And when I say ``East Asia,'' of 
course, I include China.
    The Chairman. Can I just ask you a question, interspersed 
there? Is that because you're sort of heralding the upside? You 
can look at it and see the glass, you know, in different ways, 
here. But, is the upside of that because China has so 
successfully brought so many people in from the agricultural 
sector, into an urbanized and production role, that they're 
able--that it sort of suits their interests, it's in their 
interest to have the particular products come in that come in, 
but they're still highly selective about what that is, and how 
much? Even though it's gone up significantly, we're still at an 
enormous deficit, in terms of our overall debt relationship, 
and way behind where we could be, in terms of boosting our own 
economy and kicking the entire global economy into gear.
    Ambassador Hills. Mr. Chairman, I was trying to answer the 
question you posed regarding the degree of openness in the 
China market. And the fact that our deficit with East Asia has 
declined with China being part of it suggests that it's been 
opened. It also accounts for the amount of trade that China has 
invited in.
    One of the reasons why our deficit has shifted from East 
Asia being so large a part, down, is because China has invited 
in Japan, Taiwan, Singapore, South Korea, and they are 
producing products in China. Many of the products produced in 
China are made in China, but not by China. When you buy an 
iPod, it comes to our shore at a cost of about $150, and $4 of 
that value is Chinese, which is based upon snapping together 
component parts from Japan, South Korea, and the United States.
    But having said that, the Chinese market is quite open by 
Asian standards. They're not as open as the United States. 
Their average tariff is about 9 percent, versus ours, at about 
3. And we want to continue to work with them to open their 
market. They're far more open than India, they're far more open 
than Indonesia, but they're not as open as the United States, 
which has been working on this since World War II.
    And you're absolutely right; there are some very tough 
restrictions. I listed them in my testimony. Industrial 
policies and restrictions in the form of threatened compulsory 
licensing, preferences for domestic products, subsidies for 
domestic production are real problems. We lump these 
restrictions together as ``Indigenous Innovation.'' These 
policies are of growing concern to our companies. Our Buy 
America is an irritant to the Chinese. We have issues that we 
should sit down and talk about. And I think that, when we do, 
it does help to make progress.
    And we also have the G20, which, as Laura Tyson has 
suggested, is a good forum when others share our concern. For 
example, on the revaluing of the currency, Europe, as well as 
we, believes that the currency is undervalued, to the detriment 
of their exports. By having a wider group of nations object to 
or encourage change in certain of China's restrictive policies, 
is helpful, for China wants to be on the international stage, 
and it wants to be respected. And so, it has made a number of 
changes, which are very much in its own interest, for example, 
to control inflation and to increase consumption through 
expenditures on social programs.
    The Chairman. Well, let me ask you both, quickly, if I 
can--my time's up, but I wanted to get this question on the 
table, quickly. And, Dr. Tyson, maybe you begin.
    To what degree is this economic surge by China activating, 
in your judgment--we've had a lot of focus on the economic side 
of this--a more assertive foreign policy, perhaps the rapid 
military modernization, and to what end, and mercantilist 
economic policy, to some degree?
    Dr. Tyson.
    Dr. Tyson. OK. I don't really feel that I'm an expert on 
their military policy. And I do think that, in areas that are 
trade-related and economic-related--and that can include aid 
policies to the rest of the world, the organization structure 
of multilateral institutions, and right down to a particular 
bilateral trade dispute on indigenous innovation, the Chinese 
are becoming more assertive.
    It's not just because they have done so well, but also 
because, frankly, the U.S. economy has stumbled badly, and, I 
think, around the world, the recognition that we have stumbled 
badly leads our trading partners to be more assertive in their 
relations with us. I think we have to look, therefore, to 
ourselves, of what we are going to do to restore our own 
economy on a very strong growth path, sound fiscal policy, 
going forward.
    On the issue--I just will say one thing where I think maybe 
Ambassador Hills and I have somewhat of a disagreement--I 
certainly agree, on the import side, looking at our imports 
from China--it's really important to understand that much of 
what we import from China we would have imported from other 
places, and it's moved to China to be put together and sold to 
us. And the Chinese rightly point out, all the time, that the 
value of their exports to us, or our imports from them on 
average, 25 percent of that value is Chinese-value-added, it's 
stuff they've imported. And if we were to slap significant 
tariffs on those products, the production would shift gradually 
out of China, but it wouldn't come back here. It wouldn't come 
back here. So, we--I think we have to be very cognizant of 
what--why that import imbalance looks the way it is.
    On the export side, however, I think the Chinese are moving 
in ways which I think deserve our attention. They are committed 
to becoming a technologically innovative nation. They want to 
move from a labor-intensive, low-value-added industry structure 
to a high-value-added technology structure. And that's where 
the indigenous innovation policy comes from, and preferential 
government procurement, and standards. The Chinese want to 
develop their own standard for things where there are global 
standards already that are perfectly acceptable. And when you 
sort of look at them doing this, you say, ``This looks like it 
could be in violation of their agreement on standards at the 
WTO.'' You're not supposed to create standards for the purpose 
of affecting trade flows.
    So, these are really tough issues, because they're 
nontariff barriers. And the protections in the WTO either don't 
exist, in some case, or they're inadequate; it's very hard to 
bring a case, and win.
    I think the United States, therefore, really has to engage 
the Chinese on these issues directly. And, by the way, I think 
the concern of the American business community, which I've also 
picked up, has actually been extremely helpful, because the 
U.S. Government now is taking a much tougher position on these 
things. The Chinese for a very long time, were very open to 
these companies. These major American companies that have 
become a major part of their economy--are now saying, ``We're 
not being treated appropriately or fairly.'' That becomes a 
very powerful, I think, lever for trying to get some 
negotiating progress on these issues with China.
    So, I think they've become more important, and I think we 
should focus on them at the top of our list of priorities.
    The Chairman. Senator Lugar.
    Senator Lugar. Ambassador Hills, your written testimony 
notes that, ``Immigrant-founded companies employed 450,000 
workers and generated $52 billion in revenues in 2006.'' Now, 
recently, with Senator Kerry, I introduced the Startup Visa Act 
of 2010, to allow an immigrant entrepreneur to receive a 2-year 
visa if he or she can show that a qualified U.S. investor is 
willing to dedicate a significant sum, a minimum of $250,000, 
for the immigrant's startup venture.
    What do you expect the impact of such legislation to be? Is 
it at the right levels? And, second, leaving aside the visa 
aspect, is it likely that Chinese companies will simply make 
much larger investments now in our economy? I read that, for 
example, they've noted that, as the labor costs have risen in 
China, it makes more sense to produce the goods and services in 
the United States.
    On these issues, can you give us some additional comment?
    Ambassador Hills. Let me say that my comment about the 
immigration and the need to open our nation to bright minds and 
to the development of new technology is in response to the 
question of enhancing our competitiveness. The statistics that 
we have in the Department of Commerce and Small Business 
Administration document the high number of startups created by 
foreign-born, the substantial amount of jobs they create, and 
the substantial amount of growth that they contribute to our 
economy. So, I support your Start Up Visa Act. I believe that 
65,000 H1B Visas for a country of over 300 million people is 
extraordinarily limited, plus it is very, very difficult and 
time-consuming to get a H-1B visas for people who want to come 
to the United States. It's also very difficult for a student to 
come here to study. A student can be accepted at one of our 
major universities, and not be permitted to come to the United 
States, or, after graduating, cannot be permitted to stay. 
We're just cutting ourselves off from talent and new ideas.
    I was in China last week, and I addressed the issue of 
indigenous innovation, and I said, ``You're hurting yourself by 
turning inward. When you keep out an idea, an invention, a 
patent, because you prefer to have it made at home, you hurt 
yourself not only for the loss of the idea or invention but 
also, because you create a monopoly protected from competition 
has little incentive to innovate. That protected company is not 
going to expend money to become more competitive or move up the 
value chain. But if you were to let all the ideas, inventions, 
patents come in without government interference; it would 
stimulate ideas in your domestic market. So, you're hurting 
yourself.''
    I think there's a deal here to be made that benefits both 
sides. In exchange for a relaxation of our export controls, 
China could set aside those domestic industrial policies often 
grouped under the name ``indigenous innovation.'' And I truly 
believe that.
    On the investment side, I believe that Chinese companies 
are thinking more and more of investing abroad. We need to take 
care that we do not discriminate. And we see, particularly in 
the south of our country, there are some small investments from 
the Chinese. But, they express concern, having tried to invest 
in some larger segments and not fully understanding CFIUS--
Committee on Foreign Investment in the United States--that 
operates pursuant to section 721 of the Defense Production Act 
of 1950, as amended, and the regulations that we have--that it 
is difficult to invest here. And they read our press, and they 
believe that their investors will be discriminated against, 
that they are not thought well of in our country. I think 
that's untrue. I think that most Americans think very well of 
the Chinese, applaud their miraculous rise from dire poverty to 
where they are today. And, although China's GDP on a per capita 
basis is only about one-tenth the size of ours while their GDP 
is roughly one-third of ours, they continue to make rapid 
progress. Still China has a number of challenges--e.g., 
environmental, demographic, and growing income disparity--but 
it is making progress.
    Senator Lugar. So, I gather that your sense is, essentially 
there are a good number of Chinese who are prepared to come to 
the United States and make investments--that is, personally 
locate themselves here--if our visa situation was friendlier. 
And with regard to investment in the United States, if our 
investment climate was perceived as more friendly, these 
investments would come. Therefore, at least some of us might 
argue that, in terms of creating more American jobs now and 
having more capital in the country, our diplomacy really needs 
an uptick so that there is a different set of perceptions.
    Ambassador Hills. I would agree with you entirely. I think 
we ought to open our market to foreign investment. If someone 
wants to invest a dollar or an RMB in our market, and create 
jobs and good products, that's to our benefit.
    Senator Lugar. Let me ask Dr. Tyson this question, that, in 
your written testimony, you note a significant appreciation of 
the RMB, relative to the dollar, will not have a significant 
effect on U.S. trade deficit or on U.S. employment.
    Dr. Tyson. Right.
    Senator Lugar. But, what measures, if any, vis-a-vis China, 
would have a real impact on the trade deficit or the 
unemployment rate?
    Dr. Tyson. So, what I was trying to say in that observation 
was that, basically, what matters to the overall U.S. trade 
imbalance is not the relationship with any one country. That 
was the first point.
    The second point is the point that I mentioned earlier. I 
think a significant--a dramatic overnight appreciation of the 
renminbi, versus the dollar, would initially raise prices of a 
significant number of important imports to middle-class 
Americans, and a lot of it would quickly leave China; it would 
go to different locations. It wouldn't change our trade 
imbalance.
    So, I tend to see our trade imbalance as not very sensitive 
to an appreciation. Now, I know that Fred Bergsten's numbers 
are if you had an appreciation, I think, of 20 percent over a 
5-year period, you'd get a million U.S. jobs and a reduction of 
the U.S. trade deficit of $150 billion. The problem with that 
statement is that we had something like a 20-percent 
appreciation of the RMB between 2005 and 2008, and this was the 
period when the U.S. trade deficit was going through the roof, 
and when the U.S. current account imbalance hit a peak as a 
share of GDP.
    So, I think the link between that currency value and the 
U.S. trade imbalance is a very weak link, and I would prefer us 
to think about the other factors that influence that.
    I just want to add, because I completely agree, and you saw 
me nodding my head, about the importance of inviting, or 
certainly not in any way deterring, Chinese investment in the 
United States. The Chinese have a massive amount--the largest 
holdings of United States-dollar assets in the world--and they 
are looking for ways to diversify those assets. They are 
worried about what the value of those assets will be as the 
renminbi does climb, relative to the dollar. They're worried 
about what happens to those assets if we get a spike in U.S. 
interest rates. They're worried about inflation in the United 
States over the next 20 years. They would like to diversify 
those assets.
    They don't have a lot of options. The Euro has kind of 
disappeared as an option, so they're not going to, I think, buy 
a lot of gold and, you know, put it in a building.
    I think they would like to diversify into other U.S. 
assets. And we are either the first or the second--depending 
upon, I suppose, the month--largest destination for foreign 
direct investment in the world. China's the other one. We 
welcome foreign direct investment from the rest of the world. 
We need to be sure we welcome it from China, because it is a 
better way, frankly, to alleviate our trade imbalance with 
China because some of the stuff we buy from China, imported, we 
will buy here.
    And if you think about the history of the United States 
trade imbalance with Japan, when we had significant friction 
with them in certain sectors, the Japanese moved production 
facilities here. And today, they produce significant amounts of 
product, with significant amounts of American-employed labor, 
using their technology, here.
    So, yes, I think this is very important.
    Senator Lugar. Well, I thank you very much. I would just 
underline the thought that we really ought to be thinking in 
terms of how we suggest to the Chinese they invest in our 
country----
    Dr. Tyson. Yes.
    Senator Lugar [continuing]. In addition to simply loaning 
us money.
    Dr. Tyson. Yes.
    Senator Lugar. It's a very different----
    Dr. Tyson. Exactly.
    Senator Lugar [continuing]. Concept, in terms of our own 
employment and our own economic growth.
    Dr. Tyson. Yes.
    Senator Lugar. And I appreciate both of your answers.
    Thank you.
    The Chairman. Thanks, Senator Lugar.
    Senator Casey.
    Senator Casey. Dr. Tyson, thank you.
    Dr. Tyson. Thank you.
    Senator Casey. Ambassador Hills, thank you so much for your 
testimony.
    I wanted to put my first question in the context of our 
current economic climate. When I speak of Pennsylvania, I think 
it's emblematic of a lot of places. We are, in our State, at 
about 9.1 percent unemployment, but that's 591,000 people, at 
last count--almost 600,000--a big, big number. And although I 
think we are in a recovery, we've got a long way to go.
    One of the persistent, nagging, and most difficult 
challenges we face is the problem of trade deficits. And we've 
got States like Pennsylvania that are heavily exposed to, or 
impacted by, the trade imbalance between the United States and 
China. There's obviously been a manufacturing component to 
that.
    But, I guess recently the Alliance for American 
Manufacturing reported that, contrary to some of the 
conventional wisdom, it's not simply, or only, manufacturing 
jobs, but high-technology jobs, as well, that industry.
    Another study, by the Economic Policy Institute, over a 7-
year period, in terms of what happened in Pennsylvania, a net 
job loss of more than 95,000, due to the trade deficits with 
China.
    So, all of that is predicate to a good deal of what you've 
already spoken to. I know that, Dr. Tyson, you have a series of 
recommendations, starting at page 17 of your testimony. And I 
know that, Ambassador Hills, you've got a series beginning on 
page 3--a series of obstacles that you set forth as the 
obstacles that our companies face with regard to China.
    Where's the--if you had to--if you bumped into a--on the 
street, a constituent of mine in Pennsylvania, or a similarly 
situated State, when they ask you, ``How do we bridge that gap, 
how do we begin to--at least begin to chip away at the 
problem?''--what are the two or three strategic steps you think 
we have to take, in the near term, to begin to put in place a 
strategy to get out of that hole?
    And I--either one of you want to take a crack at it, or 
both?
    Ambassador Hills. When you talk about the imbalance that 
concerns your constituents, we obviously have to bring, not 
only our bilateral, but our global imbalance into equilibrium. 
That's going to take both the United States along with other 
deficit nations and China along with other surplus nations to 
alter their models of growth. Those in deficit cannot point 
their finger at the surplus nation and say, ``You are exporting 
too much.'' Nor can the surplus nations point their finger at 
deficit nations and say you are consuming too much.'' Both 
groups need to change their growth models. It is true that 
China needs to stimulate its domestic consumption for its own 
national interests. It is also true that its currency is 
somewhat undervalued, and appreciation would help to stimulate 
domestic consumption. But appreciation of the currency is not a 
silver bullet. Currency is a factor. But, removing the 
distortions in the factors of production--land, water, fuel, 
and finance--are undoubtedly far more important factors in 
stimulating domestic consumption. China's growth model for the 
past three decades has been built on growth generated by large 
state-owned enterprises that export. And even the foreign 
investors that came in from Japan and East Asia also were 
primarily manufacturing and assembling goods for export. And 
those exports go on the account of China with the result that 
China has the largest trade surplus.
    That is not sustainable. This must change. In China it's 
creating enormous environmental problems and is contributing to 
a wage gap between rural and urban areas. When you take the 
five largest of the heavy industry, they are responsible for 
most of the pollution. Heavy metal pollution destroys about 
1,700 square miles of productive farm land each year and 
contributes to the fact that most of China's urban ground water 
is polluted. In addition China is home to the most polluted 
cities in the world. In 2007 the World Bank reported that 16 of 
the world's most polluted cities are in China. And so, for 
domestic reasons, China needs to change its model of growth 
that up to now has been disproportionately based on heavy 
industry and export. China has many challenges, including 
demographic challenges that they're going to have to deal with. 
And with 1.3 billion people, they can and need to stimulate 
domestic consumption to boost growth. That will help develop 
small and medium industries and service providers. Moving to a 
growth model that relies more on consumption will make the 
Chinese population much more satisfied, and make your 
constituents much less anxious.
    Now, at the same time, I'm sure some anxiety in 
Pennsylvania is connected to the fact that our deficit--our 
primary budget deficit--has grown to levels that frighten 
people, and our accumulated external debt adds to their 
anxiety. And so, we also must change our growth model. We can 
no longer rely disproportionately on domestic consumption, both 
public and private, to fuel our economic growth. We must get 
control of our fiscal deficit and boost private savings. And 
whether we adopt a ``pay-as-you-go'' program, and really mean 
it, or some other fiscal discipline, we need to get our fiscal 
house in order. That would provide, I think, substantial 
assurance at home and abroad that the United States economy was 
not going to have to go through a great recession in the next 
decade.
    So, there's a lot that both China and the United States 
have to do.
    Senator Casey. Dr. Tyson.
    Dr. Tyson. You've asked a very hard question, because I 
don't know, for example, the numbers of workers you announced 
that lost their jobs. I don't know how many would have been to 
a movement of a production facility to China or an import from 
China. I do know that.
    Let's take what's going on right now. In the last year, 
we've seen, particularly the last 6 months, quite strong growth 
in industrial production in the United States. We have seen a 
quite strong export of manufactured goods in the United States 
to China and the other emerging market economies. This has been 
associated with no growth in employment in manufacturing in the 
United States. That is not, therefore, a trade issue; that is a 
technology issue. That is how the U.S. companies compete, 
globally, with building manufacturing products here, and 
ramping them up, which they're doing right now, without 
increases in employment, because the technology has displaced 
the employment.
    And one of our issues in the United States is, we have to 
be clear, when employment numbers like that show up, what is it 
that's the role of China's development strategy. It may 
actually be not very important to the employment problem.
    Another thing I would say----
    Senator Casey. You mean attribution.
    Dr. Tyson. Yes. But, I would find it very difficult to talk 
to such a person, because, you know, first of all, I would have 
to understand. I mean, the second thing I would say is--
Ambassador Hills mentioned that the Chinese encourage their 
enterprises through low interest rate through subsidies. They 
encourage certain things. They want to develop their economy in 
a certain way so they subsidize certain things.
    What did we subsidize in the United States, heavily, that 
was part of the crisis? Housing. We subsidize. We absolutely 
subsidize residential construction in the United States. And a 
number of workers--25 percent, as far as I know, last count--of 
the unemployed problem in the United States is construction 
workers, who were very important to the boom that we created 
with our own interest-rate subsidy policy in the United States.
    We don't have subsidy policies to create industrial 
employment. We don't believe in them. We don't do them. China 
does them. China absolutely does them. And they've built a very 
powerful employment base in manufacturing.
    So, I think--and then, the last thing I would say--in 
looking at Pennsylvania's trade imbalance, or any country--or 
any State trade imbalance--at the end of the day, I'm not sure 
what it would look like in Pennsylvania, because there is a 
huge amount of products being bought in Pennsylvania in retail 
outlets that are primarily bought in China, and there is 
service employment in the United States that's supported by 
those imports.
    Now, this gets me to another problem in the United States. 
We have a polarization of the workforce going on. It's very 
dramatic. The unemployment rate is not high--it's high, but not 
that high--for people with a college education or higher. It's 
around 5 to 6 percent right now, in that range. The 15-percent 
unemployment rates are for high-school, or less-than-high-
school, educated workers. And those middle-income manufacturing 
jobs, that used to be a way through, for those people, to the 
middle class, don't exist anymore. And I would say, not because 
of trade with China, but because technology has displaced those 
jobs.
    So, we have a huge educational challenge in the country, 
because where the jobs are likely to grow in the future over 
the next 5 years are in college-educated and more. And right 
now we're making it more difficult, in many respects. In many 
States the tuitions for college education are going through the 
roof because of State budget problems.
    So, the Chinese, I would say, are restructuring their 
economy. They're building infrastructure in the center and 
western regions. They're introducing new social security 
policies that will reduce the household savings rate in China. 
They're doing real, structural things that will change their 
growth strategy over time.
    I don't think we're doing those. And I don't think a path 
to credible deficit reduction, which we need--I'm not saying we 
don't need it--but, that, by itself, is not a structural 
policy. That's not a structural policy.
    So, I think we have to worry about investments to make our 
economy more productive and competitive, going forward. Those 
have to be part of our strategy. It's not just a deficit-
reduction strategy.
    Senator Casey. I know we're out of time.
    Thank you.
    The Chairman. Thank you.
    Senator Shaheen.
    And I've been called to a 4 o'clock meeting, so I 
apologize.
    If you--Senator Lugar will close it out. I don't know if he 
has an additional round that he wants to ask.
    But, Senator Shaheen and then Senator Lugar.
    And I apologize. I thank the witnesses again.
    Dr. Tyson. Thank you.
    The Chairman. There will be questions------
    Dr. Tyson. Thank you for the----
    The Chairman [continuing]. For the record. I had some 
additional questions I wanted to ask you, and I know some other 
colleagues may want to submit them, so we'll leave the record 
open, if you don't mind, until the end of the week.
    Dr. Tyson. OK, that's fine. Thank you very much----
    Ambassador Hills. Thank you.
    Dr. Tyson [continuing]. For the opportunity.
    The Chairman. Thanks.
    Senator Shaheen.
    Senator Shaheen. Thank you.
    And thank you both for being here this afternoon.
    I would really like to pursue the line of questioning that 
Senator Casey started with. But, before I do that, I want to 
ask you--you talked--Dr. Tyson, you talked about the kinds of 
structural investments and changes we would need to make in 
this country in order to address some of the challenges that 
the economy faces. I certainly agree with you, relative to the 
education and the importance of making sure that a whole strata 
of people, who are not now getting higher education, need to 
get that, and the challenges that that encompasses. But, what 
else do you have in mind when you say that? And I know this is 
a little off-topic, but you just raised my curiosity.
    Dr. Tyson. Well, I personally think we have great 
innovative strengths in the United States. We still have those. 
But, I think we have to worry about the fact that we have not 
kept up our science and engineering talent base. This obviously 
goes to Senator Lugar's question. This is a very specialized--
--
    Senator Shaheen. Right.
    Dr. Tyson [continuing]. Talent base that we need to be able 
to take the basic science support, which we have, and continue 
to convert it into very successful commercial applications. And 
I look down the road, and I worry about the fact that there are 
actually projected shortages of this kind of talent in the near 
term. We're not talking about 10 years out. We're talking about 
5 years out. So, I would put a whole host of things in 
education.
    I personally think that as a transition strategy, but also 
as a strategy to support competitiveness, going forward we 
really have a major infrastructure agenda at hand.
    And I'm smiling because I just came from a lunch, where a 
number of people were talking about this. It's been well 
documented, before the great recession, that the United States 
was spending significantly less than required to just keep up 
the infrastructure it had, much less get to world quality 
standards.
    So, if you think about ports and airports and high-speed 
trains as things that promote competitiveness, they're not just 
a pleasant journey--they're that, too. I think that's an area 
of investment which has two characteristics. One, it actually 
becomes a way to create jobs for these kinds of workers who 
were in another kind of construction.
    And, by the way, I would put energy efficiency investments 
here. I've been a big supporter of the idea of doing more to 
promote households to take on energy efficient investments, 
because those are, basically, residential improvements that 
require labor to do, but they also achieve another goal.
    So, some of the things I think we should be doing are in 
the infrastructure, energy efficiency, and broadly defined 
education area. We need to say that we're going to have a 
different strategy, too, our future is going to look different, 
too.
    Senator Shaheen. Thank you.
    To go back to China, one of the concerns that I hear from 
New Hampshire business folks who are thinking about exporting 
to China is a concern that once their technology--they're 
working on a new generation of technology, whether it's in 
solar panels or, you know, Internet, or whatever--Web 
technology, whatever--that once that technology gets to China, 
that it's gone, as far as they're concerned. And so, they get 
the benefit of the first round of exports of whatever that is, 
but then it's going to get duplicated in China, and they're 
going to lose their patented technology.
    So, how do we address that? Is it through more action at 
the WTO, or are there other ways in which we can better address 
China's stealing proprietary technology?
    Ambassador Hills. When any nation fails to take measures to 
protect our proprietary technology, we should take them to the 
World Trade Organization. We have an agreement that covers 
intellectual property. It continues to be a problem in China, 
although it is improving when compared to a decade or so ago.
    China secured a number of patents last year. It moved way 
up the scale. And when you have a domestic stake in having a 
system that protects innovation, generally that causes most 
governments to take a greater interest in developing and 
enforcing rules to protect intellectual property.
    So, we're finding that China is taking a greater interest 
in protecting intellectual property. But, as they say in China, 
``the mountains are high and the emperor is far away.'' And 
what happens too often at the locality or the province level is 
not what Beijing wants to have happen. But, we have to keep 
pushing on that. And I know that some foreign manufacturers are 
sending their second-tier technology to China because of the 
very problem that you suggest. So, once again, China's hurting 
itself.
    With respect to all of these issues, it is so clear that 
opening markets to new ideas is highly beneficial. A government 
that puts restrictions that keep out inventions and new ideas 
hurts its own people. And that has been known for a long, long 
time. But, it is one of the issues that we need to watch 
carefully and deal with.
    I'd like to underscore what Laura Tyson has stated about 
the infrastructure. You know, in China they have high-speed 
trains that would take your breath away, literally. And----
    [Laughter.]
    Ambassador Hills [continuing]. And that kind of investment 
adds to a nation's efficiency, cleans up the environment as 
people pile aboard and don't get into the cars, and creates 
jobs.
    And when we talk about education, yes, we need science and 
math students to stimulate innovation here at home. So, it's 
really a great tragedy, in our great Nation that has come so 
far and once led the world in educating its youth, that today 
roughly one-third of our high school students fail to graduate. 
That is simply not tolerable in today's world.
    And so, there are a lot of things that we need to do right 
here at home. Maybe we need a commission on education bringing 
our teachers unions together with people who deal with 
educational reform, for the current situation is simply not 
tolerable. And if we continue down this road, United States 
tomorrow will not be the same United States today.
    Senator Shaheen. I couldn't agree more with both of you. I 
think one of the challenges here has been, How do you reconcile 
those needs with the deficit and the debt that we have? And--
because what you're talking about requires investment, and 
they're longer term, when we look at the returns on those 
investments. And so, how do we address the short-term need to 
respond to this growing debt and deficit that we have?
    So, I will just--I'm out of time--but, perhaps after the 
hearing, could respond to that.
    Senator Lugar [presiding]. Well, thank you very much.
    In behalf of the chairman and the members of the committee, 
I want to thank both of you for wonderful opening statements, 
which are in the record in full, and for your responses to our 
questions.
    The title of our hearing was ``Finding Common Ground With a 
Rising China,'' and you have addressed that, and I think 
members of the committee have, and perhaps increased our 
understanding, and that of those who are following our hearing.
    We will keep the record open, as the chairman suggested, 
for a few days, for additional questions and your responses.
    But, we thank you both very much.
    [Whereupon, at 4 p.m., the hearing was adjourned.]
                              ----------                              

       Additional Questions and Answers Submitted for the Record

Joint Responses of Dr. Laura D. Tyson and Stephen S. Roach to Questions 
                   Submitted by Senator John F. Kerry

    Question. Where does the Economic Relationship Fit into a Larger 
Foreign Policy Agenda: What are your views on the importance on the 
United States--China economic relationship as part of a larger United 
States-Chinese foreign policy agenda? How has the changing economic 
relationship altered our broader relationship?
    Specifically, are there ways that our economic interdependence 
constrains U.S. foreign policy options on other issues of concern, such 
as nonproliferation policy, human rights, Taiwan? Are China's foreign 
policy options similarly constrained--if so how?

    Answer. United States-China economic relationships have been a 
major focus of the larger United States-China foreign policy agenda 
during the last quarter century and that will remain the case for the 
foreseeable future. U.S. policy toward China has been one of engagement 
rather than containment or competition. The United States has welcomed 
China as an increasingly prosperous and successful member of the 
community of nations and has championed China's growing role and 
responsibilities in global multilateral institutions. And China has 
embraced economic globalization and has been a reliable global citizen 
committed to the goals of peace and prosperity. These trends are likely 
to persist: given the priority of economic growth and development to 
both its domestic political stability and the legitimacy of its 
leadership, China has too much to lose to threaten the peace and global 
economic order on which its growing prosperity depends.
    The growing economic links between China and the United States have 
strengthened the overall relationship between the two nations and have 
supported their cooperation on many shared interests including 
promoting global development, addressing global health and 
environmental challenges, and containing piracy and terrorism.
    Both China and the United States have reaped significant economic 
returns from the large trade and capital flows that link their 
economies, and both nations have to weigh these returns when they 
consider how to address areas of disagreement such as nonproliferation 
policy, human rights, Taiwan and other territorial concerns. In that 
sense, the foreign policy options of both nations are constrained by 
their economic interdependence: options that impede the trade and/or 
capital flows between them would reduce the economic welfare of both of 
them. That's why both nations should seek to address issues of concerns 
in other foreign policy areas through bilateral consultation rather 
than through unilateral confrontation, avoiding economic sanctions to 
pursue their foreign policy goals in other areas and using multilateral 
and/or regional institutions and agreements whenever possible.

    Question. National Security and the Chinese Economy: Do China's 
leaders think in terms of national security when they consider the 
size, composition, pace of development and protection of China's 
economy? If so, how does this impact their foreign and commercial 
engagement with the United States and other nations? What is the most 
appropriate and effective U.S. policy response? What is the best way to 
pursue our national economic interests and national security interest 
with China--side by side?

    Answer. Despite its dramatic economic progress, China is still a 
poor country, as measured by its GDP per capita, and confronts large 
domestic problems including large rural-urban inequalities, a 
significant pool of underemployed labor in agriculture, and 
environmental degradation from rapid industrialization. Moreover, the 
legitimacy of China's authoritarian leadership depends primarily on its 
ability to deliver rising living standards to its population. For these 
reasons, China's leaders believe that both China's national security 
and their political security depend on the growth and development of 
China's economy: these remain their primary goals and these goals are 
the primary determinants of their decisions and actions both at home 
and abroad.
    When China joined the WTO, it made significant concessions to 
liberalize its traditional trade and investment policies as part of its 
accession agreement. Since that time, China's trade has soared and it 
has gained significant shares in many global markets. In recent years, 
China has been relying more on nontraditional barriers such as 
discriminatory government procurement policies, national standards 
policies, lax enforcement of intellectual property protection, and 
local content requirements to boost the competitiveness of its domestic 
companies. Such practices impede the access of U.S. and other foreign 
companies to China's domestic market and they are a violation of the 
spirit and in some instances the law of China's WTO commitments.
    The United States should continue to treat such market access 
barriers as a priority issue in the S&ED trade discussions, should 
lodge WTO cases against such barriers, and should encourage China's 
other trading partners to address such barriers in regional and 
multilateral discussions. The United States should rely as much as 
possible on multinational, multilateral forums such as the G20, the 
WTO, the IMF and the U.N. to pursue U.S. economic interests with China 
and to address bilateral economics disagreements.

    Question. China's Treasury Holdings: China's large holdings of U.S. 
Treasury securities, which totaled $900 billion as of April 2010, make 
it the largest foreign holder of those securities.
    Some U.S. analysts welcome China's purchases of U.S. debt, which 
help enable the United States to fund its budget deficit and keep U.S. 
interest rates relatively low. Others have expressed concerns that 
China's large holdings of U.S. debt could give it significant leverage 
over the United States. How should we weigh the risks against the 
benefits?

    Answer. China's large purchases of U.S. debt over the last several 
years have indeed helped to fund the U.S. Federal budget deficit and 
have kept U.S. and global interest rates lower than they otherwise 
would have been. These purchases are a reflection of the large and 
ultimately unsustainable imbalances between saving and investment in 
both countries. The United States saves too little and consumes more 
than it produces while China saves too much and produces more than it 
consumes, relying on the United States and other nations to purchase 
its excess production. Both countries need to adjust their growth 
strategies, with the United States relying less on consumption and more 
on exports and investment to drive growth and China relying more on 
domestic demand and less on exports. The United States must also adopt 
a multiyear deficit reduction plan to stabilize the debt to GDP ratio 
at a sustainable level since dissaving by the U.S. Government is a 
major contributor to the nation's saving-investment gap.
    China has not caused the imbalance between saving and investment in 
the United States or the fiscal deficit. These are problems resulting 
from policy choices made at home. To date, the benefits of China's 
purchases of U.S. Government debt have outweighed the risks. And on 
economic grounds, China is likely to continue to purchase large amounts 
of U.S. Government's. But there are risks associated with China's large 
purchases and holdings of U.S. Government securities. In particular, as 
we argue in our testimony, even a relatively small decline in China's 
holdings could be enough to rock global financial markets, triggering a 
large increase in interest rates and a sharp decline in the dollar's 
value. China itself would suffer large capital losses on its holdings 
of U.S. securities as a result. Many observers believe that because of 
such large potential losses, there is a very low risk that China would 
use its holdings of U.S. securities to try to influence U.S. policy. In 
our testimony, we argue that this risk is higher than commonly 
perceived. For a variety of reasons identified in our testimony, a 
threat by China to move away from U.S. treasuries in order to change 
U.S. behavior or in retaliation for U.S. behavior should be taken 
seriously by U.S. policymakers. Under current financial market 
conditions, such a threat could trigger investor concerns about the 
huge financing needs of the U.S. Government, causing a sharp spike in 
interest rates and a crisis of confidence in U.S. sovereign debt that 
could cause serious economic harm to both the United States and China.

    Question. Competitiveness and U.S. Infrastructure: You mentioned 
that support for infrastructure investment in the United States was one 
way to bolster U.S. competitiveness when facing a rising China. Could 
you please explain to what extent infrastructure investment would 
reinforce U.S. competitiveness and what needs to happen to ensure 
adequate infrastructure investment at the pace and scale to ensure U.S. 
competitiveness in the future?

    Answer. A significant and sustained increase in infrastructure 
investment by Federal, State and local governments should be a 
priority. Unlike most other forms of stimulus, spending on 
infrastructure both increases demand when the spending occurs and 
increases the supply and growth potential of the economy over time The 
demand-side case for infrastructure investment is well documented. 
According to the Congressional Budget Office, infrastructure spending 
is a cost-effective demand stimulus as measured by the number of jobs 
created per dollar of budgetary cost. Moody's Economy.com estimates 
that $1 of infrastructure spending increases demand and the level of 
GDP by about $1.59.
    The supply-side or growth case for a significant increase in 
infrastructure investment is also compelling. Real infrastructure 
spending is about the same today as it was in 1968 when the economy was 
a third smaller. The inadequacies of the country's current 
infrastructure are displayed every day in freight bottlenecks, road 
congestion, and airport delays, all of which reduce business 
productivity and make the United States a less attractive location for 
business activity. Documenting these inadequacies, the American Society 
of Civil Engineers gave America's infrastructure a failing grade of D 
in its 2009 report and has identified more than $2.2 trillion in 
outstanding infrastructure needs. And using a narrower cost-benefit 
approach, a 2008 CBO study concluded that a 74 percent increase in 
annual spending on transportation infrastructure alone is economically 
justifiable.
    Over the next 5 years, the Federal Government should work with 
State and local governments and the private sector to finance $1 
trillion of additional investment in infrastructure. The successful 
Build America Bonds (BAB) program included in the current stimulus 
package should be extended to support this goal. As part of its 
commitment to a multiyear infrastructure plan, the Federal Government 
should also establish and provide the capital for a National 
Infrastructure Bank. An appropriately designed and governed national 
infrastructure bank would both address gaps and shortcomings in the 
current system for selecting and funding infrastructure projects and 
attract private investment funds for such projects. The bank would 
focus on transformative projects of national significance, like the 
creation of a national high-speed rail system or the modernization of 
the air traffic control system, that require the participation and 
coordination of many States. Such projects are neglected by the 
formula-driven processes now used to allocate Federal infrastructure 
funds among States and regions. The bank would provide both 
coordination among diverse actors and certainty about the level of 
Federal funding for such multiyear projects by removing funding 
decisions from the politically volatile annual appropriations process. 
Moreover, the bank would select projects for funding, not on political 
and earmarking considerations that too often influence project 
selection in the current system, but on independent and transparent 
cost-benefit analysis by objective experts.
    Armed with a flexible set of financing tools, including direct 
loans, loan guarantees, grants, and interest subsidies for BABs, the 
bank could provide the most appropriate forms of financing for each 
project. The bank should be granted the authority to create 
partnerships with private investors on individual projects. Public-
private partnerships would both increase the total amount of funding 
for infrastructure investments and foster efficiency in project 
selection, operation, and maintenance. Such partnerships are becoming 
common in infrastructure financing around the world and many nations 
are using them to attract private capital, but to date they account for 
a miniscule share of infrastructure financing in the United States. A 
national infrastructure bank could tap into the significant pools of 
long-term private capital in pension funds and dedicated infrastructure 
equity funds looking for infrastructure investment opportunities.
    The Federal Government can afford a capital commitment of at least 
$25 billion to establish a national infrastructure bank as an 
additional stimulus measure immediately. Given the significant excess 
capacity in the economy and the very low interest rates at which the 
U.S. Government can borrow funds, there is no danger that an additional 
stimulus of this size will trigger a crisis of confidence in the U.S. 
Government's creditworthiness. Nor is there any danger that 
infrastructure investment financed by the bank will ``crowd-out'' 
private investment--in fact, it is likely to encourage or ``crowd-in'' 
such investment.
    As the economy recovers, however, the Federal Government must 
embark on a multiyear plan to reduce the deficit and stabilize the debt 
to GDP ratio. To ease capital market anxiety about the Government's 
future borrowing needs, such a plan should be developed and passed by 
the Congress now. The plan should include permanent funding mechanisms 
for the national infrastructure bank. These mechanisms could include a 
small share of funds from a new multiyear transportation bill, a small 
share of revenues from the gasoline tax or from a new carbon tax, and 
user fees. Whenever appropriate and feasible, user fees should be 
linked to the projects financed by the bank. Such fees would not only 
raise revenues but would also encourage the efficient use of 
infrastructure assets and provide financing for their maintenance.
    The United States needs to invest significantly more in its 
infrastructure to secure its competitiveness and deliver rising living 
standards to its citizens. And there is no better time to begin that 
investment than now when millions of Americans can be put to work in 
meaningful jobs to help build the infrastructure we need.
                                 ______
                                 

Joint Responses of Dr. Laura D. Tyson and Stephen S. Roach to Questions 
                 Submitted by Senator Richard G. Lugar

    Question. At the hearing, you indicated that the United States 
needed to make structural economic changes, increase investments in 
infrastructure, increase education levels and, over the long run, 
reduce the deficit. In order to support U.S. economic growth and 
increase employment, what specific structural changes does the United 
States need to make?

    Answer. To reduce its imbalance between saving and investment and 
its unsustainable current account deficit, the United States must 
introduce policies to increase national saving and to encourage a shift 
in the composition of demand away from consumption and toward exports 
and investment. The most important step is passage of a multiyear 
deficit reduction policy that stabilizes the debt to GDP ratio at a 
stable level. This plan should include a major reform of both personal 
and corporate tax policies to encourage personal saving and business 
investment. But the plan must also increase government investments in 
infrastructure, R&D and education. Such investments are essential to 
boost the competitiveness of the United States as a location for high 
value-added economic activity and as a source of global exports.

    Question. You note in your written testimony that ``reducing 
barriers that impede the access of U.S. companies to China's markets is 
and should continue to be a major objective of U.S. trade policy.'' The 
United States participates in 49 bilateral dialogues with China 
including economics, trade, politics, energy, and health and engages 
with China in multilateral for a including the WTO, G20 and United 
Nations. What more should the United States do to advance our economic 
objectives with China?

    Answer. Reducing nontariff barriers that impede the access of U.S. 
companies to China's market is and should continue to be a major 
objective of U.S. trade policy. Given the importance of the government 
and state-owned companies in China's economy, China's participation in 
the Government Procurement Agreement (GPA) should be a major objective. 
The United States should negotiate with China to ease U.S. security 
controls on U.S. exports to China and to advance the timing for the 
recognition of China's market economy statues in the WTO (currently 
scheduled for 2016) in return for a strong offer by China to join the 
GPA. An agreement along these lines could also help revitalize the Doha 
Round talks, something that the United States and China committed to do 
at the last S&ED meetings.
    The United States should also take the lead in negotiating a Trans-
Pacific Partnership agreement as a first step toward the creation of a 
free trade area for the Asia Pacific. Several bilateral and regional 
preferential trading agreements have recently been signed in Asia and 
the region is heading toward the de facto creation of an economic bloc 
that would discriminate against the United States. The completion of a 
Trans-Pacific Partnership agreement would arrest this disturbing trend 
and could reignite APEC's leading role in global trade liberalization. 
A revitalized APEC could lead a regional effort for a free trade 
agreement on green technologies and products.

    Question. Too often around the world, the revenues from natural 
resources are a hindrance to economic and political development. 
Moreover, conflict over resource revenues can drive price instability 
and harm supply of oil. In my judgment, promoting transparency is a 
pivotal need for empowering citizens to ask questions of their 
governments and hence be empowered to grow economically and 
democratically. One measure I have offered with Senator Cardin would 
enhance U.S. leadership by requiring U.S. and foreign companies listed 
here to disclose their payments to governments as part of Securities 
and Exchange Commission filings. The importance of U.S. leadership is 
highlighted with recent mineral discoveries in Afghanistan. China's 
growing economy also requires oil, gas, and minerals, and at times the 
government backs their companies' entry into countries. In your 
assessment, how can we make progress at a governmental and corporate 
level with China to improve Chinese support for good governance of 
resources?

    Answer. A basic tenet of economics is that market efficiency and 
competition depend on information, and there is a serious lack of 
information about the terms of the deals about access to natural 
resources between governments and private companies. Without such 
information, there is also ample opportunity for corruption in the 
decisions by which natural resource rights are allocated. A compulsory 
disclosure of payments by governments to private interests in natural 
resource deals is an idea that merits serious consideration.
    China and the United States have a common interest in the gains to 
efficiency and competition and the obstacles to corruption that would 
result from global or regional agreements that enforce transparency and 
good governance in natural resource deals between companies and 
governments. The United States should raise this issue in the S&ED 
meetings with China and should explore the possibility of cooperating 
with China to foster a global agreement on this issue within in a 
multilateral organization like the U.N. or the OECD.

    Question. China is currently going through a period of labor unrest 
and wages are rising in many areas in response. Some American 
businessmen believe this wage inflation will cascade throughout much of 
the manufacturing sector. Do you believe this is likely to happen and 
if so, will Chinese officials find it too much to swallow to also allow 
their currency to appreciate? In other words would sharply rising wages 
dampen the pace and size of any currency appreciation? Would the impact 
on the United States-China trade balance of widespread wage inflation 
be similar to, or different from, the impact of currency appreciation?

    Answer. Contrary to Western press reports, China is not going 
through a period of labor unrest. The recent increases in wages are a 
conscious outgrowth of government regulations introduced in 2004, which 
stipulated that provincial governments increase minimum wages of 
Chinese workers every other year. During the crisis of 2008-09, when 
China's export businesses were under severe pressure, those increases--
like the currency appreciation policy--were suspended. The gains 
evident this year were largely a catchup from that hiatus. Even in the 
aftermath of this latest round of wage inflation, compensation per hour 
in Chinese manufacturing industries is still only about 4 percent of 
the comparable pay rate in the United States--hardly a signal that the 
days of low-cost Chinese labor are numbered. Moreover, total personal 
income in China is currently only about 42 percent of GDP--less than 
half the 85 percent reading the United States. In the upcoming 12h 
Five-Year Plan, the government will make a determined effort to boost 
the wage share of national income in an effort to raise consumer 
purchasing power. This policy should not be viewed as an offset to a 
further, albeit gradual, pace of currency appreciation in the years 
ahead. However, to the extent that it is part of a proconsumption 
policy agenda, that will absorb surplus household saving, it can be 
expected to reduce China's overall current account and multilateral 
trade surplus. Whether that translates into a smaller bilateral 
imbalance with the United States, it is equally dependent on actions 
taken by the United States to boost America's domestic saving rate--
necessary to reduce the multilateral trade deficits with China (and, by 
the way, with 89 other nations) that are an important outgrowth of our 
unprecedented saving shortfall. A critical first step is passage of a 
multiyear deficit reduction plan that stabilizes the debt to GDP ratio.
                                 ______
                                 

    Responses of Ambassador Carla A. Hills to Questions Submitted by
                         Senator John F. Kerry

    Question. Where does the Economic Relationship Fit into a Large 
Foreign Policy Agenda?

   What are your views on the importance of the United States-
        China economic relationship as part of a larger United States-
        China foreign policy agenda?
   How has the changing economic relationship altered our 
        broader relationship? Specifically, are there ways that our 
        economic interdependence constrains U.S. foreign policy options 
        on other issues of concern such as nonproliferation policy, 
        human rights, Taiwan? Are China's foreign policy options 
        similarly constrained--if so how?

    Answer. It is nearly impossible today to separate our Nation's 
economic and foreign policy issues. Challenges in one area profoundly 
affect our ability to be successful in the other, and nowhere is that 
more apparent than with respect to our relationships with China, the 
world's fastest growing large economy.
    Our Nation's stature as a foreign policy leader requires that we 
maintain a strong economy. Building a strong economic relationship with 
China contributes significantly to our Nation's growth and prosperity. 
Currently China is our third-largest and fastest growing export market. 
The benefits of our trade opportunities with China have been 
experienced across America. Virtually every state in the union 
experienced triple digit increases in exports to China in the decade to 
2008, while sales to the rest of the world over the same period grew by 
just 29 percent. With domestic consumption and investment currently 
quite weak, strong export growth gives our economy a welcome economic 
boost.
    As two of the world's major players, China and the United States 
will need to collaborate if we are to deal effectively with a long list 
of challenges like nuclear proliferation, terrorism, drug and human 
trafficking, piracy, climate change, and pandemics. It is less that we 
are constrained by our economic interdependence, and more that our 
aggregate economic strength provides a means to mobilize the capacity 
to deal successfully with a growing list of issues that cannot be 
solved unilaterally in today's globalized world. Indeed, in many 
instances both China and the United States must collaborate if 
solutions are to be found.
    We will continue to have our differences with China on economic and 
foreign policy issues as we do from time to time with even our close 
allies. But we will be better able to bridge those differences and to 
find solutions that advance the interests of our respective populations 
by taking actions calculated to build a closer, more candid and 
constructive bilateral relationship. Taiwan is a case in point. China 
regards the Taiwan issue as a ``core'' interest involving its 
``sovereignty'' and believes that we deliberately ignore its 
sensitivity. Since resuming diplomatic relations with China in 1979, 
the United States has sought to avoid debating whether Taiwan is part 
of ``one China'' but has been clear that Taiwan's future should be 
decided without the use of force. Our government pledged in the Taiwan 
Relations Act, also signed in 1979, to provide defensive weapons to 
ensure that Taiwan could defend itself again an attempt at forceful 
acquisition. At the present time, the Chinese have an arsenal of 
missiles in Fujian pointed at Taiwan, and we continue to supply 
advanced weaponry to Taiwan. The trust among our two militaries lags 
far behind the trust that exists among our leaders dealing with 
economic or strategic issues. One could imagine that if we were able to 
convene a high level and regular Strategic Military Dialogue that it 
might be possible to reach an understanding whereby China gradually 
reduced its stock pile of missiles in Fujian and as that positive 
action occurred the United States delayed sales and downgraded the 
level of weaponry sold to Taiwan. That sort of deal would require 
building a much closer and collaborative military-to-military 
relationship that today does not exist.

    Question. National Security and the Chinese Economy

   Do China's leaders think in terms of national security when 
        they consider the size, composition, pace of development and 
        protection of China's economy?
   If so, how does this impact their foreign and commercial 
        engagement with the United States and other nations?
   What is the most appropriate and effective U.S. policy 
        response?
   What is the best way to pursue our national economic 
        interests and national security interest with China--side by 
        side?

    Answer. The primary foreign policy goal of the Chinese leadership 
is to maintain peace at China's borders shared with 14 nations that 
suffer from varying degrees of instability. China seeks stability in 
the region and at home so that it can focus on its difficult domestic 
challenges including existing poverty, income disparity between rural 
and urban populations, serious environmental concerns including 
extensively polluted water supplies, foul air and loss of arable land, 
unemployment, inadequate health care, and a rapidly aging population. 
Domestically the leadership has made ``stability preservation'' its top 
priority. The leadership believes that in order to maintain domestic 
support it must implement policies that ensure that China's economy 
continues to grow in ways that will increase prosperity to those who to 
date have been left behind and to deal with the issues that affect 
quality of life in China. Over the past three decades in an effort to 
spur its economic growth, China has opened its markets to foreign 
investment and reduced its trade barriers, looking to exports and heavy 
industry to provide the engine of economic growth. Although significant 
restrictions remain, they are far fewer than existed a decade ago when 
China joined the World Trade Organization. Overall, the opening of 
China's markets has both generated domestic economic growth and 
contributed to global economic growth.
    Last year when global growth turned negative and world trade 
plummeted more than 11 percent, China, along with other nations 
including the United States, experienced a surge of economic 
nationalism. Politics in China drove ``Buy China'' policies just as 
politics here drove ``Buy America'' policies, notwithstanding objective 
economic analysis showed that such policies are detrimental to growth 
and serve to strain international relations. Bilateral fora like the 
Strategic and Economic Dialogue and the Joint Commission on Commerce 
and Trade have been helpful in removing restrictions and building 
greater understanding. Meetings of leaders and ministers that represent 
the world's 20 largest economies (the G20), that in total comprise 85 
percent of world output and 80 percent of world trade, also provide a 
useful forum for seeking to reduce trade and investment restrictions. 
Of course where a particular trade or investment policy is deemed to 
violate a WTO agreement and negotiation has not resolved the 
difference, it is appropriate to use the WTO dispute settlement 
mechanism to resolve the difference, something which both the United 
States and China have done, thus minimizing potential friction.
    In many instances the national economic interests and the national 
security interests of the United States and China overlap. Both nations 
want a vibrant global economy that contributes to domestic growth. 
Similarly both want stability internationally. In some circumstances 
where we agree on the ends, we differ with respect to the best means to 
achieve those ends. For example, China and the United States both want 
to curtail nuclear arms in Iran. China has favored extended diplomacy 
over sanctions. As a result of our strategic dialogues, China has been 
willing to support the U.N. resolutions providing for sanctions but has 
not been willing to support the tighter measures that the U.S. Congress 
adopted.
    In other circumstances we disagree on the risk involved. That is 
the case with the nuclear ambitions of North Korea. China assesses the 
risk of North Korea developing an effective nuclear weapon as lower 
than does the United States. It fears more a collapse of the North 
Korean Government, worrying it would lead to a flood of North Korean 
refuges crossing China's north east border causing instability in 
Liaoning and Jilin provinces and violating China's top domestic policy 
of ``stability preservation.'' We are more apt to find means to deal 
with both of our concerns through regular and frequent dialogue. What 
is missing today is a regular and high-level military dialogue to 
encourage both sides to better understand the other's risk assessments 
and to talk about ways to deal with our respective concerns.

    Question. China's Treasury Holdings. China's large holdings of U.S. 
Treasury Securities which totaled $900 billion as of April 2010 make it 
the largest foreign holder of those securities. Some U.S. analysts 
welcome China's purchases of U.S. debt which helps enable the United 
States to fund its budget deficit and keep U.S. interest rates 
relatively low. Others have expressed concerns that China's large 
holdings of U.S. debt could give it significant leverage over the 
United States.

   How should we weigh the risks against the benefits?

    Answer. Both those who welcome China's continued purchase of our 
growing debt and those who express concern over our increasing debt 
being in foreign hands overlook a critical point. The fact is that 
there is a serious imbalance in the global economy that has ballooned 
to unsustainable levels in recent years and puts our future economic 
stability at severe risk. China, Germany, Japan, South Korea, and other 
Asian economies have built their growth primarily on exports, whereas 
the United States, the United Kingdom, and Spain, among others, have 
relied excessively on domestic consumption, particularly in the housing 
sector, to fuel their economic growth.
    Economists agree that neither of these singly focused growth models 
is sustainable, and being unsustainable they will change either through 
gradual policy adjustment or as a result of traumatic financial 
upheaval.
    To protect against future financial crisis will require debtor and 
creditor nations to adopt more balanced growth plans. Debtor nations 
cannot continue to consume at the excessive levels of the past, and 
creditor nations must look more to their own consumers to fuel their 
economic growth.
    Most economists agree that continuing to rely on the growth models 
of the past decade raises the risk of a crisis to unacceptably high 
levels. The required changes could constructively be led by the United 
States, the world's largest debtor nation, and by China, the world's 
largest surplus nation.
    The necessary changes will take time to implement. But it would 
provide substantial market assurance if the United States and China 
would publicly lay out a specific 5-to-10-year rebalancing plan at the 
next meeting of the G20. Each could set forth benchmarks for measuring 
progress, and provide periodic updates on achievements.
                                 ______
                                 

    Responses of Ambassador Carla A. Hills to Questions Submitted by
                        Senator Richard G. Lugar

    Question. You implied that financial and trade protection would 
have a negative impact on the U.S. economy. Would you please delve into 
those details on why a rise in protectionism would have bad 
repercussions? How exactly does protectionism work itself through our 
economy?

    Answer. For the six decades following World War II, under both 
Democratic and Republican administrations, the United States has led 
the world in opening global markets. The results have been spectacular. 
America's policy of seeking to remove barriers to cross border trade 
and investment has greatly enhanced our Nation's economic growth and 
the economic well-being of its citizens. As world trade and investment 
has exploded, standards of living have soared at home and abroad.
    A highly regarded economist, Dr. Gary Hufbauer, in a comprehensive 
study published in 2005 by the Institute for International Economics, 
now the Peterson Institute for International Economics, calculated that 
the opening of markets since World War II has increased our Nation's 
GDP by roughly $1 trillion per year, thus raising the average American 
household yearly income by $9,500.
    Our trade and investment in every region of the world have 
contributed to this very positive result. Last year when trade 
plummeted by more than 11 percent, the United States economy contracted 
by about 2 percent. This year with trade up by 7 percent, the 
International Monetary Fund is predicting that the U.S. economy will 
grow by more than 3 percent. With domestic demand and job growth still 
depressed, external demand is more important than ever.
    Unfortunately economic hardship inevitably stokes demands for 
protection. Yet policies that restrict trade and investment choke off 
the growth that is especially needed in times of economic adversity. 
Making matters worse, protectionism is highly contagious. When the 
United States adopts ``Buy America'' policies, almost instantaneously 
our major trading partners, like China, implement a ``Buy China'' 
policy. Hence it behooves us to make every effort to explain to the 
public the harm that results from protectionism and the benefits that 
flow from opening markets to our products and services.
    Dr. Hufbauer's study calculates that the additional opening of 
world markets to trade and investment would increase U.S. wealth by an 
additional $500 billion per year, making the average American household 
richer by an additional $4,500 per year.
    It is well documented that jobs connected to international activity 
earn on average 13 to 18 percent more than jobs in the overall economy. 
A majority of our exporters are small- and medium-sized businesses that 
serve as the backbone of America's job creation. The prospects for 
these businesses and their workers are enhanced by our government's 
success in the opening of foreign markets.
    By ratifying the three pending trade agreements with Panama, 
Colombia, and South Korea, completing the Trans-Pacific Partnership, 
and concluding the Doha Development Round the United States could 
generate additional growth opportunities for the United States and 
global economies and help keep protectionist impulses at bay.

    Question. Your written testimony notes that one way to strengthen 
U.S. investment ties while ensuring U.S. competitiveness is for the 
United States to approve the three pending free trade agreements (FTAs) 
that have been signed with South Korea, Colombia, and Panama. Recently, 
Senator Kerry and I sent a letter to the administration calling for the 
Korea-United States FTA to be sent to the Congress for a vote. Also 
this year, I introduced a resolution in the Senate calling for the 
administration to develop a framework for FTA negotiations with the 
Association of Southeast Asian Nations (ASEAN). Over the last 5 years, 
China has signed nine FTAs including ones with Korea, New Zealand, and 
the nations of ASEAN. Please describe how U.S. business interests are 
disadvantaged when competing against China interests in areas where 
China has an FTA and the United States does not.

    Answer. Bilateral and regional free trade agreements are 
proliferating around the world. The World Trade Organization (WTO) 
finds there are 262 free trade agreements (FTAs) in force today; the 
United States is a party to just 17. An additional 100 are currently 
being negotiated. The United States is negotiating one, the Trans-
Pacific Partnership agreement. As a result our entrepreneurs and their 
workers are disadvantaged vis-a-vis their competitors in countries that 
have free trade agreements in place which affects our Nation's capacity 
to grow and to create jobs.
    That fact is starkly documented in the World Economic Forum's 
annual report ``Global Enabling Trade'' that ranks 125 countries on a 
range of factors affecting competitiveness. One factor it measures is 
tariff barriers that impede competitiveness. Chile, as a result of its 
network of trade agreements, is ranked No. 1, indicating that Chile's 
exporters face the lowest tariffs globally. The United States with few 
trade agreements is ranked 114 out of the 125 countries indicating the 
poor competitive position faced by our exporters. Of course there are 
many other trade restrictions beyond tariffs that trade agreements 
alleviate, but the metric on tariffs is illustrative.
    The job gains from our trade agreements are substantial. This past 
May the U.S. Chamber of Commerce released its study ``Opening Markets, 
Creating Jobs, Estimated U.S. Employment Effects of Trade with FTA 
Partners.'' Using a general equilibrium economic model, this study 
examined the 14 FTAs the United States has implemented over the past 25 
years, excluding three agreements most recently implemented. It found 
that 17.7 million U.S. jobs depend on trade with these 14 countries and 
5.4 million of these jobs were attributed to the increase in trade 
resulting from the free trade agreements.
    U.S. exporters can lose their competitiveness rapidly when other 
governments remove trade barriers for their entrepreneurs and our 
government does not. A study issued on May 10, 2010, undertaken in the 
House of Representatives by the ranking member of the Ways and Means 
Committee, the ranking member of the Trade Subcommittee of the Ways and 
Means Committee, and the ranking member of the Agriculture Committee 
documented that between 2004-08 Colombia's agriculture market was 
expanding at 38 percent per year and had become the largest market for 
U.S. agriculture exports in South America totaling over $4 billion. In 
2009, after Colombia entered a free trade agreement with Mercosur, U.S. 
agriculture exporters' market share in Colombia's agriculture market 
fell by 31 percent while the market share of competitors from Argentina 
and Brazil climbed 22 percent. In 1 year American saw their combined 
sales of corn, wheat, soybeans, and soybean oil plunge 62 percent even 
as Colombian total imports held steady and to date records show 2010 
sales of those products are down 45 percent.
    China is the world's largest exporter. It has arranged 14 trade 
agreements with the 31 economies including 10 nations that comprise the 
Association of Southeast Asian Nations (ASEAN), is negotiating 5 
additional agreements, and is considering negotiations with 2 large 
economies, India and South Korea.
    U.S. competitiveness in the markets where we do not have trade 
agreements but China does is being adversely affected. It should be 
noted that the network of agreements that China has and is negotiating 
in Asia will disadvantage American entrepreneurs in the world's fastest 
growing region. Sadly, the harm is self inflicted.

    Question. Too often around the world, the revenues from natural 
resources are a hindrance to economic and political development. 
Moreover, conflict over resource revenues can drive price instability 
and harm supply of oil. In my judgment, promoting transparency is a 
pivotal need for empowering citizens to ask questions of their 
governments and hence be empowered to grow economically and 
democratically. One measure I have offered with Senator Cardin would 
enhance U.S. leadership by requiring U.S. and foreign companies listed 
here to disclose their payments to governments as part of Securities 
and Exchange Commission filings. The importance of U.S. leadership is 
highlighted with recent mineral discoveries in Afghanistan. China's 
growing economy also requires oil, gas and minerals, and at times the 
government backs their companies' entry into countries. In your 
assessment, how can we make progress at a governmental and corporate 
level with China to improve Chinese support for good governance of 
resources?

    Answer. The vast majority of U.S. companies are good ambassadors 
overseas. In challenging environments they bring American values and 
demonstrate a positive agenda of corporate social responsibility. 
Expanding their competitive opportunities will lead to a spread of U.S. 
values including corporate social responsibility.
    The G20 summit meetings provide a multilateral forum where this 
issue so critical to improving global governance can be discussed 
beneficially. It is clear that transparency with respect to resource 
payments to governments would help to limit corruption, enhance global 
stability, and promote global growth. Leaders of the world's 20 largest 
economies could agree that they would support transparency with respect 
to payments made to governments for natural resources by requiring 
their companies to make such disclosure. The United States could lead 
by example by adopting the reporting measure that you have suggested.
    The Strategic and Economic Dialogue meetings provide a bilateral 
forum where the United States and China could discuss the benefits that 
would flow from transparency with respect to resource payments made to 
governments. An understanding followed by action would give tangible 
proof of the value of the bilateral dialogue.

    Question. China is currently going through a period of labor unrest 
and wages are rising in many areas in response. Some American 
businessmen believe this wage inflation will cascade throughout much of 
the manufacturing sector. Do you believe this is likely to happen and 
if so, will Chinese officials find it too much to swallow to also allow 
their currency to appreciate? In other words would sharply rising wages 
dampen the pace and size of any currency appreciation? Would the impact 
on the United States-China trade balance of widespread wage inflation 
be similar to, or different from, the impact of currency appreciation?

    Answer. China's 2010 overall inflation rate between January and May 
ranged between 1.5 percent and 3.1 percent, higher than in 2009 in the 
midst of the global recession, but considerably lower than in 2008 when 
the rates between January and May ranged between 7.1 percent and 8.5 
percent.
    There has been pressure to increase wages in the manufacturing 
sector. On July 8, Beijing issued its 2010 wage guidelines indicating 
an average 11-percent salary increase covering both government and 
enterprise workers. Undoubtedly, Chinese officials will watch closely 
to see how the higher wage rates affect both growth and inflation.
    China's competitiveness will be affected by increases in inflation 
as well as increases in wages. The benefit of wage increases, if 
inflation remains under control, is that they will encourages domestic 
consumption which will help to rebalance China's domestic economy that 
currently relies too heavily on exports and too little on domestic 
consumption for growth. Inflation driven by increases in the prices of 
consumer goods such as housing and food is likely to depress 
consumption. In recent months China has taken measures to slow the 
housing boom. There is increased recognition within China's leadership 
of the need to implement policies so as to stimulate domestic 
consumption and to reduce those that encourage expansion of heavy 
industry and exports in order to achieve a more sustainable model for 
economic growth.
                                 ______
                                 

   Responses of Ambassador Carla A. Hills to Questions Submitted by 
                      Senator Russell D. Feingold

    Question. I have serious concerns regarding past and ongoing human 
rights abuses in China, including oppression of ethnic and religious 
minorities, notably in Tibet, and of political dissidents and 
restrictions on press and assembly, just to name a few. As China 
continues its economic growth and increases its role on the world 
stage, what should we expect to see with respect to China's human 
rights record 10 years from now--positive steps and improvements or a 
continuation of repression and human rights violations? Is the issue of 
human rights being adequately addressed in our bilateral engagement, 
and how can the United States better influence the Chinese on this 
issue?

    Answer. Although it is impossible to predict with any precision the 
domestic political environment that may exist in any country a decade 
hence, my hope and expectation is that as China gains the confidence 
that comes with its enhanced economic security and increased role on 
the world stage, its leadership will respect widely accepted 
international norms including those dealing with human rights. China's 
leadership is increasingly active in international institutions 
including the United Nations Security Council, the International 
Monetary Fund, the World Trade Organization, the World Bank, and most 
recently the G20. All are built on a platform of transparent rules. 
Only by becoming a ``responsible stakeholder'' in these organizations 
can China establish and maintain a global leadership role that I 
believe its leaders want to achieve.
    China's domestic political and social reforms have been much slower 
in developing than its economic reforms that have transformed the 
country with unprecedented speed. Still there has been social change 
since the horrific revolutionary period (1960-1970) of Chairman Mao 
Zedong. Since 1978 when Deng Xiaoping began the reforms to open China 
to the world, China's Government has steadily reduced the social and to 
a lesser extent the political restrictions that the Chinese people 
faced a generation ago. However I do not see broad support for Western-
style democracy in China today where according to numerous polls the 
vast majority of Chinese believe their government is ``on the right 
track.'' Nonetheless there is considerable talk among the elite and 
scholars of the need to enhance pluralism, build an independent 
judiciary, respect the rule of law, and increase transparency.
    Over the past several years reformers in the Central Party School, 
which serves as the premier training ground for emerging Communist 
leaders, as well as university scholars have started to debate openly 
the merits of expanding grassroots political participation, judicial 
independence, and elections for top party posts. For example, in 2008 
Yu Keping, an adviser to President Hu Jintao and Professor and Director 
of the China Center for Comparative Politics & Economics in Beijing 
wrote a widely quoted book entitled ``Democracy is a Good Thing.'' 
Significantly, President Hu in his work report presented to the People 
Congress in March 2008 urged the Party ``to adapt to the growing 
enthusiasm of the people for participation in political affairs'' by 
expanding grassroots democracy, increasing transparency, and exercising 
power ``under the sunlight to ensure that it is exercised correctly.'' 
In ``Global Asia,'' a Journal of the East Asia Foundation, Yu Keping 
writes in the summer 2010 issue:

          [W]hatever political reforms China carries out, and whatever 
        kind of governance model takes shape in the future, for the 
        country's far sighted leaders the objectives of the governance 
        reform are already irrefutably clear: democracy, rule of law, 
        fairness, responsibility, transparency, integrity, efficiency, 
        and harmony.

    Similarly Zhou Tianyong, senior economist and deputy head of 
research at the Central Party School stated in a 2008 interview 
published by the Daily Telegraph: ``We have a 12-year plan to establish 
a democratic platform.'' He claimed that the government was determined 
to reform itself, but there had been some infighting between different 
departments, and he called for the number of ministries to be cut in 
half to form a ``modern government structure'' adding ``there will be 
public democratic involvement at all government levels.'' As support 
for his positive projection, Professor Zhou said: ``There will be many 
more nongovernmental organizations, chambers of commerce, industry 
associations and other social groups. Religion should also be given a 
wider platform to play a positive role. We should protect religious 
freedom.'' Although he did not predict the end of the one-party rule, 
he did state that by 2020 China will basically finish its political and 
institutional reforms.''
    People can argue about whether China will achieve those goals. But 
the fact that Communist Party members within the Party School are 
publicly talking in these terms indicates that there is some basis to 
believe that a greater liberalization of politics is underway. This 
kind of public debate regarding politics represents change for it would 
not have been permitted a decade ago.
    Public lecturing from the outside in my view is counterproductive. 
Our government can most effectively deal with human rights concerns 
where it has engaged with China on a broad range of issues of common 
interest. Working together to solve problems of mutual concern helps to 
build trust and create relationships that permits candid discussion of 
differing views and encourages the bridging of differences. There are 
instances where that has occurred. For example, China joined in 
denouncing North Korea's nuclear test in 2006, voted to impose and then 
tighten U.N. sanctions against Iran, supported deployment of U.N.-AU 
forces to Darfur, condemned the brutal crackdown in Burma, helped in 
dealing with kidnapping and piracy off the coast of Somalia, and has 
been constructive in a number of humanitarian efforts. We need to build 
on our successes. Many of our conflicts occur in areas that involve our 
militaries. Regular and frequent military dialogues at the highest 
levels would be helpful in avoiding and resolving a number of our 
differences.
    The private sector can also be helpful. NGOs continue to multiply 
in China. They are changing public perceptions. Our corporations doing 
business in China follow high standards that set an example. Also, 
there are a number of Tract II dialogues that talk about how rule of 
law, transparency and respect for minority rights contribute to 
domestic stability and counter corruption, which are objectives given 
high priority by the Chinese government.

    Question. In recent years, China has emerged as a significant 
economic and political player across Africa. Although Beijing continues 
to be primarily focused on access to oil and other natural resources, 
its engagement is matched by significant investments in infrastructure 
development, without regard to political controversies or concerns 
about governance or fiscal integrity. I don't think American interests 
on the continent are necessarily threatened by China's activity, but it 
is definitely in our interest to pay attention to this activity and 
consider its long-term strategic implications. How should we address 
that activity both in our own policy development and in our 
partnerships with African Governments, particularly given our focus on 
strengthening good governance and the rule of law?

    Answer. China's investment in and trade with sub-Saharan Africa has 
contributed to a substantial boost in the region's economic growth. 
China has given aid to most of the countries in the region excepting 
the few that still recognize Taiwan. Although it began entirely with 
what some termed ``no strings attached'' diplomacy which caused concern 
in the West as Chinese investments and aid went to governments that 
abused their populations, its policies appear to be evolving. China has 
positively responded to international pressure.
    We can applaud the fact that China's investment both in 
infrastructure and natural resources have helped to reduce poverty in 
sub-Saharan Africa. At the same time we can encourage China's active 
participation in international organizations like the International 
Monetary Fund and the World Bank that endeavor to advance rule of law, 
transparency and respect for minority rights. These issues can also be 
discussed in context of our bilateral dialogues where global stability 
is an issue of concern to both governments.

    Question. For over a decade, China has been Sudan's closest 
economic partner and its leading trade partner. China purchases about 
two-thirds of Sudan's exports, and provides one-fifth of its global 
imports. China is also the leading developer of Sudan's oil industry 
and a major purchaser of Sudanese oil. While Beijing has reevaluated 
its relationship with Khartoum in recent years, it continues to be 
reluctant to press the Government of Sudan on issues related to peace 
and security. As Sudan moves toward a 2011 referendum on self-
determination, constructive engagement from China will be 
indispensible. What can we expect from the Chinese as we get closer to 
the 2011 vote and how we can help encourage them to play a productive 
role within multilateral fora?

    Answer. The issues in Sudan are challenging. The April 2010 
election resulted in Omar Hassan al-Bashir of the National Congress 
Party being elected President of the largely Arab-Muslim North and 
Salva Kiir of Sudan's People Liberation Party elected President of the 
largely Christian and animist semiautonomous southern region. In 
accordance with the Comprehensive Peace Accord which ended 21 years of 
brutal civil war, two referenda will be held on January 9, 2011, to 
determine whether Southern Sudan will secede and form a new nation and 
whether Abyei, a region with vast oil reserves, will choose to stay 
with the North under special administrative status or to join the South 
which is expected to secede. Intraregional violence has continued in 
the South amidst allegations that the newly elected government is 
unable to maintain peace. The head of Sudan's Referendum Commission has 
warned that Sudan is ``alarmingly unprepared'' for the referendum. 
Assuming the referendum proceeds, very tough issues of border 
demarcation and sharing of oil revenues remain to be decided. Many 
outside observers have expressed the view that the African Union needs 
to be more intimately involved. President Thabo Mbeki, Chair of the 
African Union panel on Sudan, has expressed cautious optimism. The 
African Union held its summit in Kampala the last week of July to 
discuss the many daunting pre- and post-referendum concerns.
    The United Nations has extended its mission in Sudan. In late July 
United Nations representatives met with representatives of the African 
Union and expressed a willingness to work with the Sudanese Government 
and the international community to ensure a free and credible 
referendum. China, a member of the Security Council, has voiced support 
for the referendum and a strong desire for stability in the region 
where it has substantial investments. Since 2007, it has increased its 
support of international peacekeeping missions and there is no 
indication that China will alter its current policy either before or 
after the referenda. What actions the two governments take after the 
referenda will depend on the facts on the ground and future actions 
would be an appropriate subject for our bilateral strategic dialogue.

    Question. Are we paying enough attention to Chinese attitudes 
toward the United States--both those of Chinese citizens and those of 
the political and military establishments? There have been some 
troubling press stories on this issue--for example a survey conducted 
for the Sunday Times of London of Chinese-language media found ``army 
and navy officers predicting a military showdown and political leaders 
calling for China to sell more arms to America's foes.'' Similarly, the 
Washington Post reported earlier this year poll results indicating that 
many in China see the United States as ``the No. 1 threat to China's 
rise.'' Should we be doing more in the way of public diplomacy to 
China?

    Answer. There are misperceptions in both China and the United 
States about the other. Many in China, not only in the leadership and 
media but also ordinary citizens, see the United States as seeking to 
limit China's reemergence as a global leader. At the same time many 
Americans including some Members of Congress and the media talk about 
China as ``tomorrow's enemy,'' which feeds China's misperceptions 
regarding the United States and undercuts efforts to build a closer, 
more candid, and collaborative bilateral relationship. That is why 
engagement at high levels, public and private, is critical. Public 
diplomacy in China can be helpful. But we need to take steps here at 
home. It would be helpful if more of our leaders were to state publicly 
that they want to establish a closer, more candid, and collaborative 
bilateral relationship and to inform their fellow Americans about why 
and how China is important to U.S. future prosperity and security. Most 
Americans are unaware that China is our fastest growing export market 
and our third-largest customer behind Canada and Mexico. Many Americans 
complain that China limits our inward investment and take that as a 
hostile act, but are unaware that recently 50 Members of Congress have 
expressed opposition to China's Anshan Iron & Steel Group making a 20-
percent investment in U.S. Steel Development Co., a small plant

in Mississippi, that would bolster a U.S. company and create U.S. jobs. 
Many Americans see as evidence of protectionism China's procurement 
policies that seeks to limit government high technology purchases to 
``indigenous'' products, but do not see our Buy America'' restrictions 
as a rough equivalent. With a better informed public, we would be in a 
better position to build a stronger bilateral relationship that would 
benefit both sides.

                                  
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