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Annual Report by U.S. Commission Casts Critical Eye on Mainland Chinese Economic and Trade Policies

The U.S.-China Economic and Security Review Commission has released its 2016 report to Congress on the national security implications of the trade and economic relationship between the United States and mainland China. This year’s report covers key bi-lateral economic and trade issues, Beijing’s compliance with its World Trade Organisation and other multi-lateral and bi-lateral commitments, security developments, mainland China’s cyber capabilities and operations, mainland China’s trade and diplomatic relations with South Asia, and the safety of mainland Chinese food, drugs and other products as well as the role the United States may play to improve product safety in the mainland. The report comes just after the election as U.S. president of Donald Trump, who has vowed to take a harder line against mainland China on economic and security issues. The Trump administration could potentially use this report, as well as other similarly critical assessments of mainland China’s trade and economic policies, to justify a tougher stance on Beijing.

As has typically been the case, the report casts a critical eye on mainland Chinese policies and practices and makes a number of recommendations for responsive action by the U.S. government. It accuses mainland China of continuing to violate the spirit and the letter of its international trade obligations by pursuing import substitution policies, imposing forced technology transfers, engaging in cyber-enabled theft of intellectual property, and obstructing the free flow of information and commerce. The report asserts that mainland China is also becoming a less welcoming market for foreign investors with a host of restrictions and anti-competitive laws that proscribe foreign participation in broad swaths of the economy and promote domestic companies. At the same time, the report adds, the extensive subsidisation of and policy support for favoured companies and sectors puts international competitors wishing to export to the mainland at a distinct disadvantage. “It has become all too apparent,” the report states, “that the CCP [Chinese Communist Party] has no intention of opening up what it considers key sectors of its economy to significant U.S. or foreign competition and control.”

With respect to the United States, the report describes the bi-lateral relationship as strained based on mainland China’s on-going failure to uphold its WTO commitments, ineffective efforts to cut industrial overcapacity and unfair treatment of U.S. companies. U.S. companies are finding it increasingly difficult to operate in mainland China, the report notes, citing unclear laws and inconsistent regulatory enforcement, policies that favour domestic competitors and industrial overcapacity. According to the American Chamber of Commerce in China’s 2016 Business Climate Survey, more than three-fourths of surveyed U.S. companies reported that they felt foreign businesses are less welcome in the mainland than in years past.

Findings

  • The U.S. goods trade deficit with mainland China grew by 6.5 percent to a new record high of US$367.2 billion in 2015. The deficit stood at US$225.2 billion during January-August 2016, down by 5.7 percent from the same period a year earlier due to weaker imports. Mainland China has stalled on liberalising key sectors in which the United States is competitive globally, such as services.
  • The mainland Chinese government has made “supply-side structural reform” the dominant theme of economic policy. This concept includes cutting excess industrial capacity and housing inventories, deleveraging and reducing business costs. Early signs suggest the central government’s supply-side focus has not yet translated into a serious change of course. Facing a slowdown in growth, mainland Chinese policymakers have leaned on stimulus measures to boost growth. Government stimulus has largely accrued to the state sector while the private sector struggles to secure credit, endangering mainland China’s rebalancing.
  • Mainland China’s rapidly rising debt levels heighten risks to the stability of domestic financial markets, which can quickly spill over into global markets. Beijing continues to increase the flexibility of its exchange rate driven in part by its goal of internationalising the renminbi. Despite this progress, the People’s Bank of China still carefully manages the value of the renminbi, intervening in foreign exchange markets to keep the currency’s external value stable.
  • Mainland China’s foreign investment climate continues to worsen for companies in strategic industries because of the Xi administration’s focus on domestic industrial innovation goals. In addition, Beijing has forcefully argued that mainland China must reduce its dependence on foreign technology due to national security concerns and introduced stricter information and communications technology requirements and stronger cybersecurity policies.
  • While mainland Chinese investment remains a small percentage of total inward foreign direct investment in the United States, it is rising rapidly and will continue to rise driven by the mainland Chinese government’s “going out” strategy, capital flight and a generally more open policy environment for outbound investment. The record acquisition by mainland Chinese companies of U.S. assets, and particularly their drive to acquire U.S. technology firms, has led to growing political concern. However, some major mainland Chinese acquisition deals have fallen apart due to regulatory concerns or questions over mainland Chinese buyers’ ability to pay. In 2014, mainland China led foreign countries with 24 transactions reviewed by the Committee on Foreign Investment in the United States out of more than 100 total acquisition deals. Although the number of mainland Chinese transactions reviewed increased in absolute terms, it declined as a share of all mainland Chinese acquisitions and the vast majority of reviewed transactions proceed.
  • Mainland China appears to be conducting a campaign of commercial espionage against U.S. companies involving a combination of cyber espionage and human infiltration to systematically penetrate the information systems of U.S. companies to steal their intellectual property, devalue them and acquire them at dramatically reduced prices.
  • Efforts by the U.S. government to address tensions in the bi-lateral relationship continue to yield only limited results. At the final round of the Strategic and Economic Dialogue talks under the Obama administration, participants failed to achieve any major breakthroughs but left with some deliverables on financial sector co-operation. Industrial overcapacity topped the U.S. economic agenda, replacing currency as its primary concern, but mainland China only made a vague pledge with regard to steel overcapacity. The unwelcoming investment climate for U.S. companies in the mainland, along with Beijing’s recently passed law restricting foreign non-governmental organisations, also added friction to the talks.
  • Mainland China’s adherence to WTO principles and its protocol of accession remains mixed, partly due to Beijing’s opaque subsidy regime. Recently, the United States initiated WTO cases on mainland China’s aircraft taxation, export restrictions on raw materials and agricultural subsidies. The United States also requested consultations over mainland China’s continued imposition of antidumping duties on U.S. broiler chicken products in violation of an earlier WTO ruling.
  • Despite repeated pledges to let the market play a “decisive role” in resource allocation, Beijing continues to use state-owned enterprises as a tool to pursue social, industrial and foreign policy objectives, offering direct and indirect subsidies and other incentives to influence business decisions and achieve state goals. While proposed reforms have made little progress incorporating market drivers into SOE activities or addressing mainland China’s growing credit crisis, they have taken steps to strengthen state control particularly in sectors involving the government’s political or economic interests.
  • For the foreseeable future it is highly unlikely that the CCP will subject SOEs to free market reforms, as any such reforms would diminish the CCP’s control in strategic sectors and substantially increase unemployment in the short term.
  • Beijing has fostered a unique ecosystem whereby the government is at the centre of the economy, with state control extended through an array of measures including financial support, political connections, and extra-legal control to SOEs and private enterprises alike. As such, all mainland Chinese companies’ economic activity is conducted in support of the state’s goals and policies. This is particularly true for mainland Chinese firms operating in strategic sectors.
  • Mainland China’s economic policies have fuelled a commodity boom, which, coupled with the recent economic slowdown, has created a vast oversupply of industrial goods like steel, aluminium and coal. Beijing has repeatedly stated its commitment to eliminating excess capacity, yet progress has been extremely slow and in some cases non-existent.
  • Rather than closing industrial production facilities and laying off workers, Beijing is exporting its surplus production to the detriment of the United States and other foreign competitors. As a result, U.S. industries are struggling, with steel and aluminium producers shedding capacity, cutting employment and reducing capital expenditures.
  • Amid an influx of unfairly priced steel imports from mainland China, U.S. steel manufacturing jobs are being eliminated, dramatically reducing the United States’ critically important defence industrial base. If the U.S. steel industry is hollowed out, U.S. manufacturers of military equipment and machinery will be forced to import components from mainland China and elsewhere, raising the possibility that products of subpar or compromised quality could endanger U.S. military personnel and limit the country’s ability to respond to a military threat.
  • Mainland China argues that it should be automatically granted market economy status after a provision in its WTO accession protocol expires on 11 December 2016. A review of the U.S. statutory test for determining whether an economy can be classified as a market economy, including the extent to which the currency is convertible, the extent to which wage rates are determined by free bargaining between labour and management, the extent to which joint ventures or other investments by foreign firms are permitted, the extent of government ownership or control of the means of production, and the extent of government control over the allocation of resources, reveals that mainland China is not currently a market economy and is not on the path to become one in the near future.
  • To address global economic imbalances created by mainland China’s state-led economic model, the United States has relied on trade remedies consistent with its WTO obligations. However, if mainland China is granted market economy status in December 2016 dumping margins for AD cases will be significantly reduced, removing an important tool U.S. businesses rely on to limit losses taken from price distortions in the mainland Chinese economy.
  • The 13th Five-Year Plan (2016–2020) seeks to address mainland China’s “unbalanced, unco-ordinated and unsustainable growth” and create a “moderately prosperous society in all respects” through innovative, open, green, co-ordinated and inclusive growth. This agenda strengthens the CCP and the mainland Chinese government’s roles in managing the economy while allowing a greater role for markets to determine the allocation of resources in some sectors of the economy.
  • The success of the 13th FYP agenda hinges on the mainland Chinese government’s willingness to make politically difficult trade-offs between contradictory policy objectives, overcome entrenched interests and allow for greater volatility. While senior leadership has repeatedly reiterated its commitment to enacting reforms, it remains averse to the market volatility and social instability that reforms create.
  • The mainland Chinese government is increasing urbanisation, expanding public services such as healthcare and education, and pursuing limited reforms to its household registration system to alleviate poverty, boost domestic consumption, improve quality of life and create new drivers of economic growth. This transition is fuelling enormous demand in urban infrastructure and services but strict market entry criteria, opaque regulations, compulsory joint ventures and mainland China-specific technical regulations limit the market opportunities for U.S. and other foreign firms in the mainland.
  • The mainland Chinese government is building on its success under the 12th FYP to reduce greenhouse gas and air pollution and address the more technically difficult soil and water contamination under the 13th FYP. In 2016, the Ministry of Environmental Protection stepped up enforcement of its environmental standards (a key weakness of environmental reform efforts under the 12th FYP) through its new authority to conduct random inspections of provincial and municipal governments and its expansion of national, real-time monitoring systems.
  • Mainland China’s renewed focus on indigenous innovation and the creation of globally competitive firms in key emerging industries such as integrated circuits, biomedicines, cloud computing and e-commerce targets sectors in which the United States is a global leader. Continued preferential government treatment and financial support of SOEs and designated industries have lowered these firms’ cost of capital and production, creating a competitive advantage over U.S. and other private firms both within the mainland and abroad.
  • The 13th FYP requires an estimated US$8.1 trillion (RMB54 trillion) of public and private capital just to fund portions of its agenda focused on urbanisation, healthcare, and clean energy and environmental remediation. To attract sufficient investment, the mainland Chinese government is pursuing fiscal reform, encouraging public-private partnerships, increasing its government debt and loosening capital controls. Despite repeated pledges to allow the market to play a bigger role, the mainland Chinese government continues to reinforce the state’s central role in the economy. In addition, fiscal and financial reforms have yet to impose discipline and hard budget constraints on borrowers.
  • To date, the Trans-Pacific Partnership is the only fully-developed significant economic component under the U.S. strategy to rebalance to Asia. By its very nature as a free trade agreement it does not address all U.S. economic interests and objectives in the region. Other economic initiatives under the rebalance strategy have been relatively small. Trade with Asia has increased under the rebalance and U.S. trade with mainland China has grown faster than with other Asian countries. The United States has attempted to emphasise that its rebalance strategy is focused on upholding principles rather than countering mainland China for its own sake.

Key Trade/Economic Recommendations

  • Congress should amend the statute authorising the CFIUS to bar mainland Chinese SOEs from acquiring or otherwise gaining effective control of U.S. companies.
  • Congress should direct the U.S. Government Accountability Office to prepare a report examining the extent to which large-scale outsourcing of manufacturing activities to mainland China is leading to the hollowing out of the U.S. defence industrial base.
  • Congress should require that under AD and CV duty laws mainland Chinese state-owned and state-controlled enterprises are presumed to be operating on behalf of the state and, as a result, do not have standing under U.S. laws against unfair trade to block a case from proceeding.
  • Congress should create an office within the International Trade Administration whose sole purpose is to identify and initiate AD and CV duty cases to ensure a more effective and timely response to mainland China’s unfair trade practices.
  • Congress should enact legislation requiring its approval before mainland China, either as a whole or individual sectors or entities, is granted status as a market economy by the United States.
  • Congressional committees of jurisdiction should hold hearings to:

    • analyse the impact of mainland China’s state-directed plans such as the Made in China 2025 and Internet Plus on U.S. economic competitiveness and national security, and examine the steps Congress can take to strengthen U.S. high-tech and high-value-added industries such as artificial intelligence, autonomous vehicles and systems, and semiconductors;
    • ensure that U.S. government agencies such as the Treasury Department, the DOC and the Office of the U.S. Trade Representative have sufficient personnel, funding and mainland Chinese-language capabilities to examine mainland China’s economic and trade policies as well as Beijing’s compliance with its bi-lateral and multi-lateral commitments; and
    • examine U.S. access to mainland China’s domestic market, particularly for services and high-tech sectors (this hearing should assess how U.S. government agencies such as the DOC and USTR are seeking to increase market access for U.S. firms and explore what additional policy options could be pursued).
  • Congress should direct the Treasury Department to prepare a report analysing U.S. exposure to mainland China’s financial sector and the impact of financial sector reforms pursued by Beijing on the U.S. and global financial systems. The report should also identify the policies the U.S. government is or should be adopting to protect U.S. interests in response to this changing environment.
Content provided by Picture: HKTDC Research
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