other East Asian countries over the period from 1989 through 2007.<sup>12</sup> In 1989, U.S. trade with China (including Hong Kong) accounted for less than 9% of the total, Japan about 45%, and other East Asian countries about 26%. By 2008, China’s share had soared to more than 31%, while those of Japan and the rest of East Asia had fallen to around 9% each.<sup>13</sup> Increased competition from China has stimulated interest on the part of other nations in negotiating preferential trade agreements with the United States as a means of getting better-than-MFN access to the lucrative U.S. market (Bown and McCulloch, 2007). However, the nature of competition from China has been shifting rapidly. U.S. officials have signaled their displeasure that China is encouraging development in high-technology sectors, including some sectors that will offer direct competition comparable to that in the earlier U.S.-Japan episode.

In terms of overall trade patterns, there are similarities as well as differences. Like Japan, China is a major importer of raw materials, and these imports have grown at a pace similar to that of its exports. However, China is far more open to manufactured imports, both of final goods and intermediate inputs, the latter an indication of China’s much greater involvement in international vertical specialization. China’s trade to GDP ratio (2005–2007) was 71.3%, an astonishing figure given China’s size and level of development. In contrast, the corresponding ratio for the United States was 27.2% and for Japan 31.5%.<sup>14</sup> Another significant difference is the role played by foreign direct investment (FDI). The first of China’s export-oriented Special Economic Zones (SEZs), which opened in 1980, encouraged FDI through preferential treatment of foreign investors.<sup>15</sup> By 2004, China’s stock of inward FDI stood at $702 billion, with an FDI to GDP ratio of 0.42, compared with Japan’s 1986 stock of $7 billion, a negligible share of GDP. Indeed, even by 2004, Japan’s FDI stock was still only $97 billion, and its FDI to GDP ratio was just 0.02.<sup>16</sup> While Japan and China both achieved rapid productivity improvement through

> 12 We follow common practice in expressing national and regional bilateral imbalances as shares or fractions of the overall U.S. imbalance.  Note, however, that some U.S. bilateral balances are positive. Moreover, this presentation may suggest that movements in individual bilateral balances are determined independently, while in fact they can be linked causally.  In particular, the reduction over time in the shares of Japan and other East Asian countries reflects relocation via direct foreign investment of processing activities to China.

13 These shifts reflect the growth of China’s “processing trade” in which Chinese subsidiaries of Japanese manufacturing firms import intermediate inputs from Japan and export final goods to the United States. Similar supply chains link China to other more advanced neighbors in East Asia, such as Korea and Taiwan. See Dean, Lovely, and Mora (2009); Van Assche, Hong, and Ma (2009); and Greaney and Li (2009).

14 WTO (2008a). Data for China do not include Hong Kong, with a ratio of 397%, nearly half of which represents exports to the mainland.

15 One result may have been round-tripping of mainland capital, i.e., mainland investors routing funds through Hong Kong firms in order to qualify for the preferential treatment reserved for FDI.

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