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Annual Report by U.S. Commission Highlights Threats and Opportunities in Trade with Mainland China

The U.S.-China Economic and Security Review Commission has released its 2017 report to Congress on the national security implications of the trade and economic relationship between the United States and mainland China. The report warns about a continuing backslide in trade liberalisation as the mainland Chinese government policy contributes to rising protectionism and unfair regulatory restrictions that have left more than three-quarters of U.S. firms responding to a recent survey feeling less welcome in mainland China than they did a year earlier. However, the report also sees opportunities for U.S. companies in the mainland Chinese market.

The report states that the U.S. trade deficit in goods with mainland China, which President Trump has vowed to take strong action to address, totalled US$347 billion in 2016, the second-highest on record, and was up 6.2 percent year-on-year in the first eight months of 2017. On the other hand, the U.S. services trade surplus with mainland China reached a record high of US$38 billion in 2016, up from US$438 million in 2006.

The report observes that mainland China’s strong income growth, expanding middle class and stated plans to rebalance to a more consumption-driven economy should further boost U.S. services trade with the mainland. At the same time, mainland China maintains market access barriers that restrict U.S. services companies, including caps on foreign equity, discriminatory licencing requirements and data localisation policies. In addition, the opening of mainland China’s services sector to foreign participation has been slow and it may thus be increasingly difficult for U.S. companies to become significant players.

The report also finds several reasons to be concerned about mainland Chinese foreign direct investment in the United States that has “increased dramatically in recent years.” One is that mainland Chinese FDI is targeting industries deemed strategic by the mainland Chinese government, including information communications technology, agriculture and biotechnology, leading to the transfer of valuable U.S. assets, intellectual property and technology to mainland China. In many of these sectors, U.S. firms lack reciprocal treatment in the mainland and are forced to disclose valuable technologies and source code to gain access to the mainland Chinese market. A second reason is that some mainland Chinese companies operating in strategic sectors are private only in name, with the mainland Chinese government using an array of measures to influence private business decisions and achieve state goals. Third, some mainland Chinese companies are attempting to invest in sensitive U.S. industries without obeying normal U.S. regulatory procedures through methods such as facilitating investments through shell companies based outside mainland China and conducting cyber espionage campaigns to financially weaken and then acquire U.S. firms.

Key Findings

  • The U.S. trade deficit in goods with mainland China totalled US$347 billion in 2016, the second-highest deficit on record. In the first eight months of 2017, the goods deficit increased 6.2 percent year-on-year to US$239.1 billion, with U.S. exports to mainland China reaching US$80.2 billion, an increase of 15 percent year-on-year, while imports from mainland China grew 8.3 percent year-on-year to US$319.3 billion. In 2016, the U.S. services trade surplus with mainland China reached a record high of US$37 billion, driven almost entirely by an increase in mainland Chinese tourism to the United States.
  • Mainland China’s foreign investment climate continues to deteriorate as government policy contributes to rising protectionism and unfair regulatory restrictions on U.S. companies operating in the mainland. The newly implemented cybersecurity law illustrates this trend because it contains data localisation requirements and a security review process that U.S. and foreign firms claim can be used to discriminatorily advantage mainland Chinese businesses or access proprietary information from foreign firms.
  • U.S. government efforts to tackle mainland China’s trade-distorting practices continue to yield limited results. The inaugural Comprehensive Economic Dialogue, created following a meeting between President Trump and President Xi in April 2017, concluded with no concrete agreements or future agenda.
  • At the World Trade Organisation, the United States continues to challenge mainland China’s non-compliance with key provisions of its accession agreement, including failure to notify subsidies. In the past year, the United States requested WTO consultations over mainland China’s management of tariff rate quotas for rice, wheat and corn, as well as subsidies to select producers of primary aluminium.
  • Mainland Chinese government policies, coupled with increased investor uncertainty in the mainland, have contributed to increased investment flows to the United States in recent years. In 2017, mainland Chinese investment flows to the United States are expected to decline relative to 2016 as the mainland Chinese government seeks to limit capital outflows and fend off risks from mounting corporate debt.
  • Sectors of the U.S. economy deemed strategic by the mainland Chinese government are more likely to be targeted by mainland Chinese firms for investment, while mainland Chinese investments in non-strategic sectors like entertainment, real estate and hospitality are declining amid Chinese Communist Party efforts to limit capital outflows and reduce corporate debt.
  • Some mainland Chinese firms seek to obscure their dealings in the United States through U.S.-based shell companies or attempt to drive down the value of U.S. assets through sophisticated cyberespionage campaigns. These firms are becoming more sophisticated in their attempts to circumvent Committee on Foreign Investment in the United States reviews and other U.S. investment regulations.
  • The application of the sovereign immunity defence to commercial cases presents a potential risk for U.S. businesses and individuals, allowing mainland Chinese state-owned enterprises to conduct unlawful activity in the United States without legal consequences. Some mainland Chinese SOEs are evading legal action in the United States by invoking their status as a foreign government entity under the Foreign Sovereign Immunities Act.
  • The opaque nature of mainland China’s financial system makes it impossible to verify the accuracy of mainland Chinese companies’ financial disclosures and auditing reports. Mainland Chinese businesses continue to list on U.S. stock exchanges to raise capital despite operating outside the laws and regulations governing U.S. firms.
  • U.S. regulators have struggled to deter mainland Chinese fraud schemes on U.S. exchanges, with mainland Chinese issuers stealing billions of dollars from U.S. investors. Efforts to prosecute the issuers of the fraudulent securities have been unsuccessful, with mainland Chinese regulators choosing not to pursue firms or individuals for crimes committed by mainland Chinese companies listed overseas.
  • Mainland China’s rebalancing to a more consumption-driven growth model should present opportunities for U.S. companies in the e-commerce, logistics and financial services sectors. However, U.S. companies operating in the mainland do not have a level playing field and continue to face significant market access challenges, including informal bans on entry, caps on foreign equity, licencing delays and data localisation policies.
  • Mainland China is the largest e-commerce market in the world, with e-commerce sales reaching US$787 billion in 2016. According to the DOC, by 2019 an estimated one out of every three retail dollars in mainland China will be spent on-line, the highest percentage in the world. Although mainland China has traditionally provided the world with its manufactured goods, its e-commerce boom should offer increased opportunities for U.S. retailers and brands, with more and more mainland Chinese consumers purchasing foreign goods. Demand is strong in areas where the United States excels, such as high-quality foods and supplements, beauty products and healthcare-related goods.
  • Although mainland China’s e-commerce market offers opportunities for U.S. retailers and brands, it is not without its challenges and risks. While the mainland Chinese government has made some improvements in enforcing intellectual property rights, intellectual property issues remain a key challenge for U.S. companies operating in the mainland. In particular, the prevalence of counterfeit goods on mainland Chinese e-commerce platforms continues to hurt U.S. retailers and brands.
  • E-commerce has been a key driver of improvements to mainland China’s US$2.2-trillion-dollar logistics sector. Yet, the domestic logistics industry remains underdeveloped due to mainland China’s historical focus on improving export logistics at the expense of domestic logistics infrastructure. This has caused logistics to become a major bottleneck for mainland China’s e-commerce sector. Efforts to develop and modernise the express delivery industry could offer U.S. logistics firms like FedEx and UPS opportunities to expand their operations in the mainland.
  • Financial services have been a major driver of growth within mainland China’s services sector, increasing 11 percent annually from 2012 to 2016. However, mainland Chinese consumers’ access to financial services remains inadequate and most mainland Chinese consumers lack formal credit histories. Improving their access to financial services will be critical for raising domestic consumption levels. In addition, mainland China has made limited progress in implementing reforms to improve the market orientation and efficiency of its financial sector.
  • Mainland China has become a global leader in financial technology. Its Internet giants have emerged as significant players not only in e-commerce and logistics, but also in mainland China’s financial services sector, particularly in payments and lending.

Key Trade/Economic Recommendations

  • Congress should consider legislation updating the CFIUS statute to address current and evolving security risks. Among the issues Congress should consider are:
    • prohibiting the acquisition of U.S. assets by mainland Chinese state-owned or state-controlled entities, including sovereign wealth funds;
    • requiring a mandatory review of any transaction involving the acquisition of a controlling interest in U.S. assets by mainland Chinese entities not falling under the above class of acquiring entities;
    • requiring reviews of investments in U.S.-based greenfield assets by mainland Chinese-controlled entities to assess any potential harm to U.S. national and economic security;
    • expanding the definition of “control” to include joint ventures, venture capital funds, licencing agreements and other arrangements or agreements that enable mainland Chinese entities to access and/or determine the disposition of any asset;
    • prohibiting any acquisition or investment that would confer “control” with regard to critical technologies or infrastructure;
    • including a net economic benefit test to assess the impact of acquisitions by mainland Chinese entities in the United States to ensure they advance U.S. national economic interests;
    • requiring that any proposed acquisition of a media property by a mainland Chinese entity be assessed in terms of the acquiring entity’s history of adhering to mainland Chinese Communist Party propaganda objectives and its potential to influence public opinion in the United States;
    • authorising an independent review panel, appointed by Congress, to review the actions and activities of CFIUS on a continuing basis; and
    • allowing any CFIUS member agency to bring a transaction up for review and investigation.
  • Congress should consider legislation conditioning the provision of market access to mainland Chinese investors in the United States on a reciprocal, sector-by-sector basis to provide a level playing field for U.S. investors in the mainland.
  • Congress should amend the Foreign Sovereign Immunities Act of 1976 to allow U.S. courts to hear cases against a foreign state’s corporate affiliates under the commercial activity exception and require mainland Chinese firms to waive any potential claim of sovereign immunity if they do business in the United States.
  • Congress should consider legislation to ban and delist companies seeking to list on U.S. stock exchanges that are based in countries that have not signed a reciprocity agreement with the Public Company Accounting Oversight Board.
  • Congress should direct USTR to develop criteria for the Notorious Markets List to ensure listed companies can be held accountable for engaging in or facilitating copyright piracy and trademark counterfeiting.
  • Congress should require USTR to expand the National Trade Estimate’s coverage of mainland China’s digital trade barriers to include an assessment of their impact on U.S. industries and whether they comply with mainland China’s WTO commitments.
Content provided by Picture: HKTDC Research
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