Globalization and Clashes of Economic Powers - US and China - Part 1

The U.S.-China Trade and Economic Relationship

China held to its hybrid model of a state-directed economic system throughout 2008 as it consolidated its position as one of the world’s fastest-growing countries. Alone among the world’s major economies, China refuses to allow the renminbi (RMB), its currency, to respond to free market movements. China’s leaders instead keep the currency trading at an artificially low level in order to suppress export prices—a deliberate violation of the rules of the International Monetary Fund, of which it is a member. As a result of this and other factors, China’s current account surplus with the United States and the rest of the world soared and added to China’s record foreign exchange reserves of nearly $2 trillion when this Report was completed, up from $1.43 trillion at the publication of the Commission’s Report a year ago. China began employing thisforeign exchange in new ways. Rather than using it to improve the standard of living for the Chinese people through education, health care, or pension systems, China began investing the money through new overseas investment vehicles, including an official sovereign wealth fund, the China Investment Corporation. Despite statements by Chinese leaders that they seek only financial gain from diversifying their investments into equity stakes in western companies,there are increasing suspicions that China intends to use its cash to gain political advantage globally and to lock up supplies of scarce resources around the world. Other Chinese government economic policies harmed the United States, China’s trading partners, and its own citizens. China made scant progress in reining in the rampant counterfeiting and piracy that deprive legitimate foreign businesses operating in China of their intellectual property, while they provide an effective subsidy to Chinese companies that make use of stolen software and other advanced technology. Chinese regulators failed to prevent the domestic sale and export of consumer goods tainted with industrial chemicals and fraudulent ingredients. In one case examined by the Commission, China’s lax controls on the production and handling of its seafood exports led to a partial U.S. ban for health reasons on imported Chinese seafood. Yet, thanks to artificially low prices partly resulting from an array of subsidies to its seafood industry, China has become the largest exporter of seafood to the United States.



The U.S.-China Trade and Economic Relationship’s Current Status and Significant Changes During 2008

* China’s trade surplus with the United States remains large, despite the global economic slowdown. The U.S. trade deficit in goods with China through August 2008 was $167.7 billion, which represents an increase of 2.4 percent over the same period in 2007. Since China joined the WTO in 2001, the United States has accumulated a $1.16 trillion goods deficit with China and, as a result of the persistent trade imbalance, by August 2008 China had accumulated nearly $2 trillion in foreign currency reserves. China’s trade relationship with the United States continues to be severely unbalanced.

* The U.S. current account deficit causes considerable anxiety among both economists and foreign investors who worry that future taxpayers will find it increasingly difficult to meet both principal and interest payments on such a large debt. The total debt burden already is having a significant impact on economic growth, which will only increase in severity.

* China’s currency has strengthened against the U.S. dollar by more than 18.5 percent since the government announced in July 2005 it was transitioning from a hard peg to the dollar to a ‘‘managed float.’’ Starting in July 2008, however, the rate of the RMB’s appreciation has slowed, and there are some indications this may be due to the Chinese government’s fear that a strong RMB will damage China’s exports. China’s RMB remains significantly undervalued.

* China continues to violate its WTO commitments to avoid trade distorting measures. Among the trade-related situations in China that are counter to those commitments are restricted market access for foreign financial news services, books, films and other media; weak intellectual property protection; sustained use of domestic and export subsidies; lack of transparency in regulatory processes; continued emphasis on implementing policies that protect and promote domestic industries to the disadvantage of foreign competition; import barriers and export preferences; and limitations on foreign investment or ownership in certain sectors of the economy.

* Over the past year, China has adopted a battery of new laws and policies that may restrict foreign access to China’s markets and protect and assist domestic producers. These measures include new antimonopoly and patent laws and increased tax rebates to textile manufacturers. The full impact of these laws is not yet known, particularly whether they will help or hinder fair trade and investment.

* In 2008, China emerged as a stronger power within the WTO as it took a more assertive role in the Doha Round of multilateral trade talks, working with India and other less-developed nations to insist on protection for subsistence farmers.

China’s Capital Investment Vehicles and Implications for the U.S. Economy and National Security

* The significant expansion of the Chinese government’s involvement in the international economy in general and in the U.S. economy in particular has concerned many economists and government officials due to uncertainty about the Chinese government’s and the Chinese Communist Party’s motivations, strategies, and possible impacts on market stability and national security. At the same time, cash-strapped U.S. firms have welcomed the investments, viewing them as stable and secure sources of financing in the wake of the credit crunch.

* China’s government uses a number of state-controlled investment vehicles among which it chooses depending on its particular investment purposes and strategies; most widely known among such vehicles are China Investment Corporation (CIC), the State Administration for Foreign Exchange (SAFE), and China International Trust and Investment Corporation (CITIC).

* Some aspects of China Investment Corporation’s mandate follow China’s industrial policy planning and promotion of domestic industries by, for example, investing in natural resources and emerging markets that are relevant for the advancement of China’s value-added industries. CIC and SAFE form just one part of a complex web of state-owned banks, state-owned companies and industries, and pension funds, all of which receive financing and instructions from the central government, promote a state-led development agenda, and have varying levels of transparency. Many of their investment activities contravene official assurances that they are not being managed to wield political influence.

* Regulations governing investments by sovereign wealth funds, especially disclosure requirements pertaining to their transactions and ownership stakes, are still in development, both in the multilateral arena and in the United States. There is concern that the Chinese government can hide its ownership of U.S. companies by using stakes in private equity vehicles like hedge or investment funds.

* China’s foreign exchange reserves continue to grow, while its management of the exchange rate has given it monopoly control on outward flows of investment. This strongly suggests that China will have a very substantial and long-term presence in the U.S. economy through equity stakes; loans; mergers and acquisitions; ownership of land, factories, and companies; and other forms of investment.Research and Development, Technological Advances in Some Key Industries, and Changing Trade Flows with China.

* China has been pursuing a government policy designed to make China a technology superpower and to enhance its exports. Some of its tactics violate free market principles—specifically its use of subsidies and an artificially low RMB value to attract foreign investment. Foreign technology companies, such as U.S. and European computer,aerospace, and automotive firms, have invested heavily in research and development and production facilities in China, sharing or losing technology and other know-how. Chinese manufacturers have benefitted from this investment. The U.S. government has not established any effective policies or mechanisms at the federal level to retain research and development facilities within its borders.

* China’s trade surplus in advanced technology products is growing rapidly, while the United States is running an ever-larger deficit in technology trade. China also is pursuing a strategy of creating an integrated technology sector to reduce its dependence on manufacturing inputs.

* China seeks to become a global power in aerospace and join the United States and Europe in producing large passenger aircraft. China also seeks to join the United States, Germany, and Japan as major global automobile producers. So far as China competes fairly with other nations, this need not be a concern. But China’s penchant for using currency manipulation, industrial subsidies, and intellectual property theft to gain an advantage violates international norms.

China’s Activities Directly Affecting U.S. Security Interests

China’s record of proliferating weapons of mass destruction or effect has improved in recent years, and the nation has played a significant role in some important nonproliferation activities such as the Six-Party Talks intended to denuclearize North Korea. However, the United States continues to have concerns about the commitment of China’s leadership to nonproliferation and to enforcing the strengthened nonproliferation laws and procedures the nation has established and about China’s refusal to participate in some international nonproliferation agreements and regimes. The United States also is concerned that the nuclear power technology China is selling to other nations may result in nuclear proliferation.

China increasingly is devising unique interpretations of agreements or treaties to which it is a party that have the effect of expanding the territory over which it claims sovereignty and rationalizing such expansions, particularly outward from its coast and upward into outer space. This development, coupled with its military modernization, its development of impressive but disturbing

capabilities for military use of space and cyber warfare, and its demonstrated employment of these capabilities, suggest China is intent on expanding its sphere of control even at the expense of its Asian neighbors and the United States and in contravention of international consensus and formal treaties and agreements. These tendencies quite possibly will be exacerbated by China’s growing need for natural resources to support its population and economy that it cannot obtain domestically. The United States should watch these trends closely and act to protect its interests where they are threatened.

China’s Proliferation Policies and Practices

* China has made progress in developing nonproliferation policies and mechanisms to implement those policies. Although it is apparent that China is making some meaningful efforts to establish a culture and norms supporting some aspects of nonproliferation within its bureaucracy and industry, gaps remain in the policies, the strength of government support for them, and their enforcement.

* Although China has acceded to numerous international agreements on nonproliferation and has cooperated with the United States on some nonproliferation issues (e.g., the Six-Party Talks),China has been reluctant to participate fully in U.S.-led nonproliferation efforts such as the Proliferation Security Initiative and in multilateral efforts to persuade Iran to cease its uranium enrichment and other nuclear development activities.

* China’s support for multilateral negotiations with North Korea can help to reduce tensions on the Korean Peninsula, open North Korea to dialogue, and improve bilateral relations among the countries participating in the process—which may be crucial ingredients for peace and cooperation in northeast Asia and beyond.

* Experts have expressed concerns that China’s sales or transfers of nuclear energy technology to other nations may create conditions for proliferation of nuclear weapons expertise, technology, and related materials. These activities also could feed the insecurities of other nations and cause them to pursue their own nuclear weapons development efforts. This could lead to an increase in the number of nations possessing nuclear weapons capability.

China’s Views of Sovereignty and Methods of Controlling Access to its Territory

* China’s leaders adamantly resist any activity they perceive to interfere with China’s claims to territorial sovereignty. At times this priority conflicts with international norms and practices.

* Some experts within China are attempting to assert a view that China is entitled to sovereignty over outer space above its territory, contrary to international practice. If this becomes Chinese policy, it could set the stage for conflict with the United States and other nations that expect the right of passage for their spacecraft.

* China has asserted sovereignty over the seas and airspace in an Exclusive Economic Zone that extends 200 miles from its coastal baseline. This already has produced disputes with the United States and other nations and brings the prospect of conflict in the future.

* Any assertions by Chinese officials of sovereignty in the maritime,air, and outer space domains are not just a bilateral issue between the United States and China. The global economy is dependent upon the fundamental principles of freedom of navigation of the seas and air space, and treatment of outer space as a global ‘‘commons’’ without borders. All nations that benefit from the use of these domains would be adversely affected by the encroachment of Chinese sovereignty claims.

* China’s efforts to alter the balance of sovereignty rights are part of its overall access control strategy and could have an impact on the perceived legitimacy of U.S. military operations in the region, especially in times of crisis.

* China is building a legal case for its own unique interpretation of international treaties and agreements. China is using ‘‘lawfare’’ and other tools of national power to persuade other nations to accept China’s definition of sovereignty in the maritime, air, and space domains.

The Nature and Extent of China’s Space and Cyber Activities and their Implications for U.S. Security

* China continues to make significant progress in developing space capabilities, many of which easily translate to enhanced military capacity. In China, the military runs the space program, and there is no separate, distinguishable civilian program. Although some Chinese space programs have no explicit military intent, many space systems—such as communications, navigation, meteorological, and imagery systems—are dual use in nature.

* The People’s Liberation Army currently has sufficient capability to meet many of its space goals. Planned expansions in electronic and signals intelligence, facilitated in part by new, space-based assets, will provide greatly increased intelligence and targeting capability. These advances will result in an increased threat to U.S. military assets and personnel.

* China’s space architecture contributes to its military’s command, control, communications, computers, intelligence, surveillance, and reconnaissance (C4ISR) capability. This increased capability allows China to project its limited military power in the western and southern Pacific Ocean and to place U.S. forces at risk sooner in any conflict. Cyber space is a critical vulnerability of the U.S. government and economy, since both depend heavily on the use of computers and their connection to the Internet. The dependence on the Internet makes computers and information stored on those computers vulnerable.

* China is likely to take advantage of the U.S. dependence on cyber space for four significant reasons. First, the costs of cyber operations are low in comparison with traditional espionage or military activities. Second, determining the origin of cyber operations and attributing them to the Chinese government or any other operator is difficult. Therefore, the United States would be hindered in responding conventionally to such an attack. Third, cyber attacks can confuse the enemy. Fourth, there is an underdeveloped legal framework to guide responses.

* China is aggressively pursuing cyber warfare capabilities that may provide it with an asymmetric advantage against the United States. In a conflict situation, this advantage would reduce current U.S. conventional military dominance.