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Addressing Concerns on
Advisor: Geza Feketekuty
March 5, 1999
ADDRESSING CONCERNS ON THE GROWING US TRADE DEFICIT WITH CHINA
TABLE OF CONTENTS
This is a project researched and prepared by Lijuan Zhang and required for the MA in Commercial Diplomacy (MACD) offered by the Monterey Institute of International Studies (MIIS). Lijuan Zhang is a Fulbright scholar from the People's Republic of China, and is a graduate of the MACD program. As a Chinese scholar, she has great interest in the study and research of US-China trade relations. This research project has been conducted as part of the program requirements for the MACD.
For purposes of this project, I will assume the role of Advisor working for the US-China Trade Promotion Council, with the responsibility to develop a comprehensive strategy to address US-China trade relations, focusing on concerns of US-China trade deficit issues.
The advisor on this project is Professor Geza Feketekuky, founder of the MACD program and a former senior trade official in the office of the United States Trade Representative (USTR).
The issue for the United States is how to resolve the growing trade deficit with China while maintaining and improving both the political and trade relationship between these two important nations.
China has clearly become a major participant in the world economy. It is virtually certain to become even more important in the future because of its size, dynamic economic growth, and continuing policy reforms. However, along with increasing US-China trade, there is growing concern regarding the trade deficit with China.
This project addresses the entire array of commercial, policy, and political issues now being discussed between the United States and China, and provides domestic, negotiation, media and legislative strategies regarding the US-China trade deficit issue.
This project conducts a comprehensive analysis of the US-China trade relations, and offers a range of recommendations for both the US and Chinese government as they undertake the always complex task of improving their relationship.
RECOMMENDATIONS FOR THE US GOVERNMENT:
The US government should take steps to improve public understanding of the US-China trade relationship and the evolving economic and political situation in China.
Specially, the US should take steps to:
1. Explain the progress that China has made regarding its trade policy practices.
2. Acknowledge China's progress towards a market economy.
3. Emphasize the importance of US-China trade in order to establish a more solid foundation for a constructive trade relationship with China.
RECOMMENDATIONS FOR THE CHINESE GOVERNMENT:
The Chinese government should accelerate its domestic reforms, consistent with its long-term economic development strategies.
Specially, the Chinese government should take steps to:
1. SCENARIO AND ISSUE
2. OUTLINE OF THE PROJECT
--Trade Deficit Background
--Chinese Trade Policy
5. ANALYSIS OF THE SUBSTANTIVE POLICY
6. DOMESTIC STRATEGY
7. NEGOTIATION STRATEGY
8. MEDIA STRATEGY
9. LEGISLATIVE STRATEGY
10. WHITE PAPER
ADDRESSING CONCERNS ON THE GROWING US TRADE DEFICIT WITH CHINA
As an advisor of a hypothetical organization—the US-China Trade Promotion Council, I will develop a comprehensive strategy to address the concerns of both the US and Chinese governments and industry regarding the growing US trade deficit with China.
There are three reasons for both the US and China to reduce tensions surrounding the bilateral trade imbalance.
First, China and the US are two of the most important nations in the world. China is the largest developing country while the US is the largest developed country. Working together, they can shape a more effective global trading environment.
Second, the US and China have mutual economic and trade interests. Bilateral trade between the US and China has developed rapidly since 1979, but the tensions generated by a growing trade imbalance have become a concern to both governments.
Third, in the interest of global stability, the US must work to help build a civil society in China.
At present, the US is deeply concerned over the growing trade deficit with China. US trade with China produced a 1997 deficit of $49.7 billion, up from $39.5 billion in 1996. Further, the US deficit with China is closing in on the US’s largest bilateral deficit, the deficit with Japan. Analysts believe this trend will result in the deficit with China surpassing the imbalance with Japan as early as this year. The trade imbalance issue will be one of many issues raised by opponents of Normal Trade Relations (NTR, formerly MFN) renewal. As China is a potential pre-eminent economic power for the 21st century, it is crucial for the US government to make bilateral and multilateral efforts in every forum to open the Chinese markets, and to put an end to the growing US trade deficit with China.
However, China argues that the US-China trade imbalance is not as large as the US claims. China also argues that it has made significant progress in its domestic economic regime and trade policy reform during the past ten years and is in position to join the international trade system and have normal bilateral trade relations with the United States. Additionally, China is prepared to take some further trade liberalization measures. However, China does not believe it should be required to do anything or take any measures that would disrupt its economic reform strategy and domestic economic and political stability.
As achievements are being made in various areas of economic and trade cooperation, the US and China still hold different views on the true size of the trade deficit issue (See Exhibit #8). However, viewed as a whole, development and cooperation between these two nations stand out as the main theme. Therefore, the best way to resolve these differences is a thorough and constructive dialogue leading to mutually supportive economic and political steps. Confrontation should be avoided because it will not help solve the differences.
this goal, I will provide strategies for building a consensus inside
the US, and inside China. I will also suggest practical steps the US
government can take to improve US-China trade relations, as well as
steps the Chinese government can take to strengthen its trade policy
reform, to further open markets, and to provide a better policy environment
for foreign trade. I will develop separate strategies to address each
aspects of this research project.
RECOMMENDATIONS TO THE US GOVERNMENT
The US government should take steps to improve public understanding of the importance of the US-China trade relationship, and the evolving economic and political situation in China. The following steps would be very helpful:
1. Explaining the progress that China has made regarding its trade policy practices and their impact on the US-China trade
A clear understanding of the trade deficit has profound implications for the national debate regarding US trade policy with China. At present, there are some misunderstandings about US interests in this area. These misunderstandings have spawned a number of debates about trade policy towards China. In order to improve US-China trade relations, the US government must help to educate and ensure the public that China has made important commitments and established a legal foundation for economic and administrative reform. Even with these efforts, enforcement will not occur overnight.
Areas of substantial Chinese trade policy progress include:
Other areas in which significant commitments have been made include:
2. Demonstrating China’s progress towards a market economy
The establishment of a market economy system is crucial to China’s future. All trade and economic issues are closely related to how globally integrated China allows its economy to become. The more open the Chinese market system, the more opportunities the US industries will have. Therefore, for the Chinese government, the first priority should be to establish a complete market economic system within its Ninth Five-Year Blue Plan. There is no doubt that China has made substantial progress in the last ten years to decentralize its economy and trade. For example, most prices are decided by the market rather than by the government; SOEs may determine production levels and in many cases the prices of their products. These have created growing trade opportunities for the US industries.
3. Emphasizing the importance of US-China trade
These two important nations will play key roles in the global economy, since China is the largest developing economy and the US is the largest developed economy. The most important thing the US government can do at this time is to build a more harmonized relationship with China to convince the American people that China will play a crucial role in major international issues which the US will face in the decades to come, and that a normal trade relations with China is in America’s commercial and strategic interest. The President must convince Congress to pass legislation to establish normal trade relations with China.
At present, China is the sixth largest importer of US agricultural products, and the biggest importer of civilian aircraft from the US. US technology is highly respected the world over and China is creating a bright future for the US to export its technology. The US is now China’s 2nd largest trade partner while China has grown into the 4th largest trade partner with the US. It is clear that the US has greatly benefited from China's open-door policy.
With respect to jobs and growth, China has become the 6th largest agricultural market for US growers, with exports to China and Hong Kong now supporting over 400, 000 American jobs. Meanwhile, China is a crucial part of the recovery process from the Asian financial crisis, which already affects the US economy. However, the debate now within the administration is whether to initiate retaliatory actions against China or to give China some breathing room in view of the suffocating economic conditions in the region. The US should base its China policy on its long-term interests and be fully aware the US interest can only be served by a secure, stable and open China.
The US import statistics has ignored entrepot trade and value added from entrepot trade, and this lead to over-estimate its imports from China. According to the US information, 20% of Chinese goods are directly shipped to the US, while the remaining 80% get into the US through a third place, mainly through Hong Kong. Therefore, the added value created at the third place after the goods have left China should not be calculated as exports from China. While only about a quarter of the US re-exports to China via Hong Kong was included in the US statistics of its exports to China.
Since Hong Kong is a part of China now, the US should
change its statistical method, and include Hong Kong in its statistics
regarding the US-China trade balance.
RECOMMENDATIONS TO THE CHINESE GOVERNMENT
The Chinese government should accelerate its domestic reforms and comply with its long-term economic development strategies already made. For these purposes, the following strategies need to be considered:
1. Explain to the public the necessity and benefits of further market access
China must explain to its own public that open markets are the trend of the world economy. Free trade, characterized by market access and fairness, accelerates economic growth and investment, raises real wages, and enhances productivity growth. Most businesses benefit from open markets because alternative sources of supply enhance competitive pressures on domestic firms, forcing them to improve their products and their methods of production to keep pace with the competition. By contrast, protection makes domestic industries lose opportunities and provides no pressure to improve competitiveness.
Currently, China’s main concern for further market opening is its domestic and infant industries. It is understandable to protect the domestic industry during a development period, but this protection must be eliminated in the end. In fact, China has benefited from its open door policy. Therefore, further opening of markets must be put on the trade policy agenda as soon as possible.
2. Inform the US public of China’s progress to improve free trade and promote the US's benefits from these efforts
One of the most important strategies the Chinese government can implement is to better educate the world about China. China has been pursuing a more open market for twenty years. However, the great achievements that China has made are not that well known to the US public. Therefore, China must inform the US public what has been accomplished and what can still be done towards free trade.
3. Continue the progress of establishing a civil society
China’s economic development has helped to make great improvements in human rights in recent years. People enjoy more democratic rights, and benefit from the fast growing economy. However, China still has more work in building a civil society, providing private interaction by individuals, associations, religious organizations, and businesses. With development of a good civil society and respect of individual citizens by government authorities, people can then enjoy their own lives by making individual choices. Meanwhile, China needs to work towards building an understanding with the rest of the world. By increasing opportunities for dialogues at all
levels of society, particularly with its main trading partners, China is moving towards a more open society.
4. Maintain momentum of domestic economic reforms
China must keep its domestic reform on schedule in order to build a solid foundation for a long-term economic growth and trade development. The Chinese government should be aware of the importance of its success and continue its current domestic reform, such as SOEs reform, banking system reform, and social welfare system reform.
5. Take some further trade liberalization measures consistent with the domestic reform strategy
The Chinese government should making use of the
new opportunity created by its domestic reform to further liberalize
its trade. The Chinese economy and trade are becoming an important part
of the global economy. China must take some further trade liberalization
measures, consistent with its domestic economic reform.
TWO VIEWS OF THE US-CHINA TRADE IMBALANCE
China is one of the most important trading partners of the United States. According to Department of Commerce (DOC) statistics for 1998, total US-China trade measured $85.41 billion, a 13.4% increase over 1997, making China America's fifth-largest trading partner. In 1998, US exports to China climbed 11.3% from 1997 to $14.25 billion, while imports grew 13.8% to $71.15 billion. This created a new trade deficit with China of 56.9 billion at the end of 1998, causing the US trade deficit with China to expand by 18.6% to $11.5 billion, second only to Japan. This is one of the largest trade deficits.
Growing concern over the US trade deficit with China
has plagued the bilateral relationship in recent years. Fueled in part
by consistently strong US imports of toys, footwear, small electronic
items, and apparel, the US deficit with China also has worsened due
to Chinese market access restrictions, including both barriers at the
border and restrictive regulations at all level of government. The deficit
is the focus of discussions at the highest levels of both governments,
and is one of the crucial issues on the 1998 US trade agenda.
US Trade Deficit with China
1. Trade Deficit Background
In 1997, the US merchandise trade deficit with China was $49.7 billion, an increase of $10.2 billion from 1996, and an approximate 50% increase since 1995, when the merchandise trade deficit with China stood at $33.8 billion. China marked the 11th straight annual increase in the deficit with the US.
Following the 1997 record deficit, the US merchandise trade deficit for 1998 was $56.9 billion. The deficit with China increased from $49.7 billion in 1997 to $56.9 billion in 1998. As the full impact of the Asian financial crisis is felt, the US trade performance will show a sharp deterioration. Steep devaluation of Asian currencies will make these products cheaper in the American market while making it harder for US exporters to sell into Asian markets. The widening trade gap is likely to add to the US government’s headaches. Within one year, the US trade gap with China will likely be worse than with Japan.
2. Trade Structure
The US Department of Commerce reported that the flood of Chinese clothing, shoes, and toys are main contributors to this growing trade gap.
In terms of trade in services for 1996, the US exported $3.1 billion to China and imported $2.0 billion from China, resulting in a positive services trade balance with China of $1.1 billion.
In terms of Foreign Direct Investment (FDI) in 1996, the stock of US FDI in China was $2.9 billion, an increase of 36% from the level of US FDI in 1995. At present, the US FDI flows to China continue to increase. US FDI in China is concentrated largely in the manufacturing and petroleum sectors.
3. Trade balance accountings
The US import statistics does not calculate value added from entrepot trade, and its export statistics does not calculate the US re-exports to China. Therefore, the size of US trade deficit with China has been largely exaggerated. For example, the average rate of value-adding of Chinese exports to the US via Hong Kong was 40.7% in 1996 and 1997, which was calculated as imports from China, and thus greatly over-calculated the US’s real import value from China.
4. US Reactions
The growing trade deficit with China is unacceptable to the US and it is becoming an increasingly important issue for both nations.
US industry continues to express concerns over China’s significant trade barriers. US parties assert that China is seeking to build international competitiveness by protecting various sectors.
The US government has complained that China’s lack of
market access and transparency hurts the US and is doing very little
to change the situation. For these reasons, the United States continues
to block China’s entry into the WTO, and to impose trade sanctions on
some Chinese products.
Chinese Trade Performance
China has increasingly strengthened the protection of foreign business under its legal system, and steadily improved its trade and investment policy environment.
In the past few years, China has taken a series of important measures in improving its trade regime and policies:
However, China is not an open and free market. For example, China still maintains restrictive import policies, such as high tariffs and taxes. Although China reduced tariffs several times in 1996 and 1997, most of the tariff reductions have been on low volume imports. The Chinese government determines the level of import flows through licenses, quotas, and other non-tariff measures, such as the "automatic" registration requirements, electromechanical product import control measures, regulations on the administration of medical equipment, and camera import control measures.
3. China Reactions
China is aware of US concerns regarding the trade imbalance. This has been highlighted through commercial and diplomatic channels especially through the long-lasting negotiation process of its WTO entry. However, China is focusing on further reforms in several fields, such as state-owned enterprises (SOEs), and banking system reform. Because of political and economic constraints, China cannot finish all of these reforms overnight. Therefore, the process of more fully opening the Chinese economy will take a relatively long period. The Chinese government still has a long way to go to build the domestic economic and political basis for major liberalization of its trade regime.
With respect to the trade deficit issue, China argues that the US exaggerated the deficit figure and the US statistics are faulty. China says the 1997 deficit was actually $16.4 billion rather than $47.9 billion (US statistics), and it attributes the discrepancy to US accounting methods. Meanwhile, China argues that US export controls against China are a major obstacle for US exports. For these reasons, China has tried to improve trade relations with other countries in the event of possible US trade sanctions.
1. THE COMMERCIAL ISSUES
To the US, the most important commercial issue is how the US firms’ commercial interests in China can be pursued.
(1) Constructive relations and balanced trade with China directly affect US firms’ business expansion in China
US firms' success in China is critical in order for them to maintain global competitiveness. China is the US's fifth largest trading partner. Since 1990, US exports to China have doubled, outpacing the growth of US exports to any other major export market. US manufactured goods, services, and farm exports to Hong Kong and China (a substantial portion of US exports to Hong Kong are re-exported to China) totaled roughly $35 billion in 1997 (See Exhibit # 2), and support close to 400,000 American jobs. As a large growing market, China can only provide great opportunities to US businesses on the basis of normal trade relations.
(2) Openness of the Chinese market and Chinese trade barriers affect US trade growth
China is one of the most important trading partners of the US, and it is going to play more crucial role in the global economy. Therefore, Chinese trade policies and practices have a substantive impact on the development of US trade.
(3) Only under the same market rule, can US products ensure its competitive advantages
The US has a strong commercial interest in ensuring that Chinese goods entering the US market are produced on the basis of market principles, since China is becoming one of the largest sources of imported goods. Otherwise, such a large amount of Chinese imported goods would distort the US domestic market system.
To China, the most important issue is that the US market is its largest market, and Chinese trade and economic development relies more on the US market.
2. SUBSTANTIVE POLICY ISSUES
For the US government, the most substantive policy issue is how to develop better public support for establishing normal US-China trade relations.
Basic public misunderstanding has put pressure on government and Congress to restrict trade with China. The US government needs to do more to develop better public understanding of the situation in China to ease some of that pressure. The US also needs to revise the basis for calculating the US-China trade and then develop a new value-added balance.
Since the existing misunderstanding of the economic and trade developments in China has affected the public confidence in building normal trade relations with China, the first issue for the US government is to develop an effective strategy for increasing public understanding. US influences could push the Chinese government to further liberalize its trade policies more quickly. However, to wield US influence effectively requires sustained domestic support. The public must grow accustomed to the idea that China may well be America’s main foreign policy focus for the foreseeable future. As China grows stronger economically and militarily, the US government needs to conduct constructive US-China trade relations more sensitively.
The second policy issue is how to improve China's trade policy reforms in order to create more opportunities for US industries
The focus of this issue is how to manage China’s emergence as a major global power. This will profoundly impact the shape of the global order and the future prosperity of US industries. China has a huge growing market for advanced technologies, equipment and other production materials and certain commodities in which the American aircraft, sophisticated machinery, electronics, chemicals, grain, timber and fertilizer are taking a remarkable share. The Chinese market is now more important to US industries than at any period in history.
The third policy issue is how to ensure that the Chinese government complies with commitments already made, and takes practical steps to further open its markets
Further reform of China’s trade policies could provide enormous benefits not only to the US and China, but to the whole world. However China will define its own destiny. The question is, what exactly will China agree to do? It is important for China to understand the seriousness with which the US views the US-China trade relations. Only then can the US push China to take practical steps, such as:
For the Chinese government, the first substantive policy issue is what steps China can take to solve the trade deficit issue and to improve the climate for foreigners doing business in China.
At present, the trade imbalance has become a crucial issue for US-China relations. Increasing concerns inside the US seriously affect public and policy-makers' confidence on China trade policy. China must take this issue seriously. Meanwhile, the Chinese government must be aware of the importance of providing a transparent and rule-based trade climate for foreigners doing business in China.
The second key policy issue is how to accelerate its domestic reforms and remain consistent with its long-term economic development objectives.
The Chinese government has correctly identified three linked objectives—the reform of the SOEs, the banking system and the social welfare system—as top priorities. However, during the trade liberalization process, the Chinese government sometimes stopped just short of further reform in order to wait for changes in international and domestic situations. China will not be able to build a solid foundation for long-term economic growth without keeping domestic reform. The Chinese government must be aware of the effectiveness and need of continuous strategic reforms.
The third policy issue is how to further liberalize and reform its domestic regulations in order to provide a more transparent and predictable policy regime
If China wants to take advantage of the opportunities
created by the new economic era, it must seek to reform its domestic
regulations. The most immediate challenge is to establish transparency
and predictability in its regulations. Further more, China needs to
move from a system of entry and licensing controls to a regulatory system
based on transparent, objective and measurable performance criteria.
Such a system will increasingly determine its economic growth and prosperity.
3. THE POLITICAL LANDSCAPE
At present, inside the US and China, almost every issue has a political as well as an economic component. Political disputes heavily shape the US-China trade relationship. Inside the US, the most prominent issues are the following:
The US-China Deficit
American politicians are deeply concerned regarding the increasing US trade deficit with China, but they also should realize the following facts:
China’s WTO Accession and Normal Trade Relations (NTR) Renewal
China’s WTO accession is important in several respects. While China and the US both want to reach an agreement on the terms of China’s entry, China will not gain membership over US objections.
Inside China, remaining import barriers are primarily protecting state-owned industries in order to avoid international competition. Because these state-owned industries still employ almost two-thirds of all urban workers, China’s political leadership appears unwilling to risk the high levels of urban unemployment that could result if restructuring was too rapid. Thus, the costs of conforming immediately to expectations of the West on openness to trade are relatively high for China while the gains from membership in the WTO are relatively small. The single most important economic benefit associated with China’s membership in the WTO is the permanent most-favored-nation (MFN), now the normal trade relations (NTR) status in the markets of member countries. However, permanent MFN is bestowed by all WTO member countries, except the US. The US has provided MFN status for China one year at a time for more than fifteen years.
US policy tools will be limited to less-effective unilateral levels if China remains outside the WTO. Therefore, the best way to resolve these concerns is with greater communication and increased dialogues, rather than with confrontation.
There is no doubt that healthy US-China trade relations
will require ongoing attention to the political as well as the economic
challenges for a long time to come. As for China, it still has a long
way to go before it has a well-functioning market economy. And it is
apparent that China's internal politics will remain unsettled for many
Establishing A Consensus inside the US
In light of the US-China trade imbalance issue, the US government and business must fully realize the importance of addressing this crucial area.
The US should adopt a strategy that would:
China should adopt a strategy that would:
The US political strategy should:
The Chinese political strategy should:
The development of a negotiation strategy for US negotiators identifies the different parties, their interests and options surrounding the trade relations between the US and China. The negotiation strategy examines US and China preferred outcomes, options, and Best Alternatives to a Negotiated Agreement (BATNA). This project provides:
The key factors that contribute to the increasing US trade deficit with China are:
The preferred outcome would be the establishment of a transparent trade policy and more liberalized market access to be provided to the US exporters in China.
Acknowledge China’s trade liberalization progress, but confirm that China needs to do more in terms of further trade reform. Otherwise, the slow-down of trade liberalization will affect not only the US-China bilateral trade relations, but also China’s entrance to the multilateral trading system the WTO.
If the bilateral negotiation cannot achieve the preferred outcome, the US trade policy should consider:
On the Chinese side, the key factors that contribute to the US-China trade deficit are:
--Deepen state-owned enterprises reform
American and Chinese negotiators have significantly different negotiation and problem solving characteristics, which must be considered before and during the formal negotiation process. The following chart provides a better understanding to the cultural background faced during the implementation of the negotiation and different strategies for the US and China.
Media can be a powerful tool to reach a broad audience.
US MEDIA STRATEGY
The us media strategy provides a plan for using the media to:
Domestic Media Strategy
International Media Strategy
It will be necessary to implement a domestic and international media strategy that promotes China’s market economy and further reform. The government should use the domestic media to educate the public about the benefits of a more open market as well as the necessity of further domestic economic and administrative reform, and use international media strategy to convince the world about China's achievements in building a market economy and further steps towards a more open market.
Domestic Media Strategy
The goals of the domestic strategy are to build a new consensus on US-China trade relations, to explain the benefits of open trade for Chinese companies and workers, as well as acknowledge the challenges of the global trading systems and be prepared to respond to those challenges. Therefore, the domestic strategy needs to reach out to all Chinese.
International Media Strategy
Organize an international conference at the time of the Twenty Anniversary of China's Open-door Policy. This can provide a good opportunity to let the world know more about China.