[Joint House and Senate Hearing, 108 Congress]
[From the U.S. Government Publishing Office]





    IS CHINA PLAYING BY THE RULES? FREE TRADE, FAIR TRADE, AND WTO 
                               COMPLIANCE

=======================================================================

                                HEARING

                               before the

              CONGRESSIONAL-EXECUTIVE COMMISSION ON CHINA

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

                           SEPTEMBER 24, 2003

                               __________

 Printed for the use of the Congressional-Executive Commission on China


         Available via the World Wide Web: http://www.cecc.gov


                                 ______

90-833              U.S. GOVERNMENT PRINTING OFFICE
                            WASHINGTON : 2003
____________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
Fax: (202) 512ï¿½092250 Mail: Stop SSOP, Washington, DC 20402ï¿½090001


              CONGRESSIONAL-EXECUTIVE COMMISSION ON CHINA

                    LEGISLATIVE BRANCH COMMISSIONERS

House

                                     Senate

JIM LEACH, Iowa, Chairman            CHUCK HAGEL, Nebraska, Co-Chairman
DOUG BEREUTER, Nebraska              CRAIG THOMAS, Wyoming
DAVID DREIER, California             SAM BROWNBACK, Kansas
FRANK WOLF, Virginia                 PAT ROBERTS, Kansas
JOE PITTS, Pennsylvania              GORDON SMITH, Oregon
SANDER LEVIN, Michigan               MAX BAUCUS, Montana
MARCY KAPTUR, Ohio                   CARL LEVIN, Michigan
SHERROD BROWN, Ohio                  DIANNE FEINSTEIN, California
DAVID WU, Oregon                     BYRON DORGAN, North Dakota
                                     

                     EXECUTIVE BRANCH COMMISSIONERS

                 PAULA DOBRIANSKY, Department of State*
                 GRANT ALDONAS, Department of Commerce*
                   LORNE CRANER, Department of State*
                   JAMES KELLY, Department of State*

                      John Foarde, Staff Director

                  David Dorman, Deputy Staff Director

* Appointed in the 107th Congress; not yet formally appointed in 
  the 108th Congress.

                                  (ii)


                            C O N T E N T S

                              ----------                              
                                                                   Page

                               STATEMENTS

Opening statement of Hon. James A. Leach, a U.S. Representative 
  from Iowa, Chairman, Congressional-Executive Commission on 
  China..........................................................     1
Levin, Hon. Sander M., a U.S. Representative from Michigan.......     2
Levine, Henry A., Deputy Assistant Secretary, Asia Pacific 
  Policy, U.S. Department of Commerce, Washington, DC............     3
Freeman III, Charles W., Deputy Assistant U.S. Trade 
  Representative for China, Office of the U.S. Trade 
  Representative, Washington, DC.................................     4
Martin, Gary C., president and CEO, North American Export Grain 
  Association, Washington, DC....................................    29
Smith, Brad, managing director, international affairs, American 
  Council of Life Insurers, Washington, DC.......................    30
Hatano, Daryl, vice president of public policy, Semiconductor 
  Industry Association, San Jose, CA.............................    33
Primosch, William, director, international business policy, 
  National Association of Manufacturers, Washington, DC..........    35
Lau, Lawrence J., Kwoh-Ting Li professor of economic development, 
  Stanford University, Stanford, CA..............................    42
Pearson, Margaret M., professor of government and politics, 
  University of Maryland, College Park, MD.......................    44
Huang, Yasheng, associate professor, Sloan School of Management, 
  Massachusetts Institute of Technology, Cambridge, MA...........    47

                                APPENDIX
                          Prepared Statements

Levine, Henry A..................................................    58
Freeman III, Charles W...........................................    59
Martin, Gary.....................................................    63
Smith, Brad......................................................    67
Hatano, Daryl....................................................   138
Primosch, William................................................   142
Lau, Lawrence J..................................................   147
Pearson, Margaret M..............................................   153
Huang, Yasheng...................................................   158

Leach, Hon. James A..............................................   172
Hagel, Hon. Chuck................................................   173
Baucus, Hon. Max.................................................   174
Kaptur, Hon. Marcy...............................................   175
Levin, Hon. Sander M.............................................   176

 
    IS CHINA PLAYING BY THE RULES? FREE TRADE, FAIR TRADE, AND WTO 
                               COMPLIANCE

                              ----------                              


                     WEDNESDAY, SEPTEMBER 24, 2003

                            Congressional-Executive
                                       Commission on China,
                                                    Washington, DC.
    The hearing was convened, pursuant to notice, at 10:20 
a.m., in room SD-419, Dirksen Senate Office Building, 
Representative James A. Leach [Chairman of the Commission] 
presiding.
    Also present: Senators Hagel, Thomas, Levin, and Dorgan; 
Representatives Bereuter, Dreier, Wolf, Pitts, Levin, Kaptur, 
Sherrod Brown, and Wu.
    Also present: Paula Dobriansky, Under Secretary for Global 
Affairs, U.S. Department of State.

OPENING STATEMENT OF HON. JAMES A. LEACH, A U.S. REPRESENTATIVE 
  FROM IOWA, CHAIRMAN, CONGRESSIONAL-EXECUTIVE COMMISSION ON 
                             CHINA

    Chairman Leach. Let me bring this hearing to order. Chuck 
Hagel will be here briefly. Let me just make a quick opening 
statement.
    Let me say, we have a rather profound panel on a number of 
the issues before us, particularly those of trade.
    I just returned from a trip to the Far East and I am one 
that is a very strong believer in free markets when it comes to 
currency as well as commodities. I spoke very directly to 
Chinese officials in this regard.
    I am a believer that one of the great skewing factors in 
international trade today are currency relationships, and that 
if you do not have a free market in currency, countries can 
manipulate trade to their advantage. Also, it is implicitly to 
the disadvantage of wealth of their own societies.
    But trade advantages, definitely, they can do that. The 
great trauma in the U.S.-Chinese relationship is the trade 
imbalance, and it is something that I think this Congress is 
going to have to be increasingly concerned with. That is one 
reason for the discussion and the group of people that we have 
asked to address the Commission today.
    Does anyone else want to make any opening comments? Yes, 
Sandy.
    [The prepared statement of Chairman Leach appears in the 
appendix.]
    Representative Levin. I just wanted to enter a statement in 
the record.
    Representative Kaptur. May I also ask, if we wish to submit 
a statement for the record, will that be permitted?
    Chairman Leach. It will absolutely be permitted, and anyone 
is entitled to do that.
    Representative Kaptur. Thank you.
    Chairman Leach. And to revise and extend any other remarks 
you have made as well.
    Representative Kaptur. Thank you.
    [The prepared statement of Representative Kaptur appears in 
the appendix.]

 STATEMENT OF HON. SANDER M. LEVIN, A U.S. REPRESENTATIVE FROM 
                            MICHIGAN

    Representative Levin. So I will ask the same, Mr. Chairman. 
I have a statement that relates to the hearing, but it also 
probably somewhat reflects my feelings about the Commission's 
annual report and the need for this Commission to be a center 
of activity.
    Let me just say this, and the hearing, I think, will 
underline this. The purpose of this Commission that emanated 
from our debate on PNTR was to help this country both engage 
China and to pressure it, to put it bluntly, as it opens up, as 
it moves forward, as it becomes increasingly a vital part of 
the global economy, and indeed the global structure.
    I think trying to meet both objectives means that we should 
be direct when we have issues with China. I think the purpose 
of this Commission is to focus on those issues that are 
basically within its purview, human rights, including worker 
rights, the rule of law, and the more this Commission can find 
a way to be both direct and also engaging China, I think, the 
better our relationship will be. Thank you.
    [The prepared statement of Representative Levin appears in 
the appendix.]
    Chairman Leach. Well, I appreciate that.
    Does anyone else want to make an opening comment?
    [No response.]
    Chairman Leach. Let me, before beginning, also indicate 
that in discussions in China 3 or 4 weeks ago, we proposed that 
there are certain types of things that the United States and 
China can deal with on a different level than involved in 
politics or trade, and that is the subject of culture.
    With the support of the National Endowment of the Arts, we 
are moving in the direction of developing an art and artists 
exchange program with China that I think is intended to 
underscore that, on certain levels that go beyond politics and 
go beyond economics, there can be respect for each other's 
societies, and that ought to be emphasized.
    So, the Commission need not necessarily formally endorse 
that approach, but I think it is something that makes a lot of 
sense. I just want to put that on the table as well.
    At this point, if there are no more opening statements, I 
would like to turn to our panelists. The first panel is 
composed of Charles Freeman, who is the Deputy Assistant U.S. 
Trade Representative for China, and Henry Levine, who is the 
Deputy Assistant Secretary of Commerce for Asia Pacific Policy.
    We have before us in Mr. Freeman and Mr. Levine two 
distinguished public servants, and we welcome them. If Mr. 
Freeman is not here yet, why do we not begin then with the 
testimony of Mr. Levine.

STATEMENT OF HENRY A. LEVINE, DEPUTY ASSISTANT SECRETARY, ASIA 
  PACIFIC POLICY, U.S. DEPARTMENT OF COMMERCE, WASHINGTON, DC

    Mr. Levine. Certainly, Mr. Chairman and members of the 
Commission. Thank you, first, very much for inviting me to 
participate in this hearing.
    The Department of Commerce is committed to making sure that 
China plays by the rules, and we continue a very active set of 
efforts in that direction in coordination with our colleagues 
in the interagency process.
    I will summarize my statement and will submit the full text 
to the Commission.
    In fact, I recently returned from China with my boss, 
Assistant Secretary for Market Access and Compliance Bill Lash. 
On that trip, in addition to laying the groundwork for the 
upcoming visit of Secretary Evans, we also met with senior 
officials to discuss China's WTO compliance and other trade 
issues.
    Assistant Secretary Lash repeatedly stressed the need for 
China to implement its WTO commitments fully and on time. I 
certainly do not need for the members of this Commission to 
rehash the statistics which underscore the high stakes involved 
here, whether it is China's growth, the growth of its economy, 
its growth as an international player in world trade, or the 
soaring bilateral trade deficit.
    I would, however, just note that, certainly in my job day 
in and day out, I tend to focus on the problems in the economic 
relationship. I would note, though, that amidst those problems 
there are some positives.
    I think it is worth noting that since 2001, China has been 
by far the fastest growing export market among our top 10 
trading partners, with our exports growing something in the 
neighborhood of 22 percent this year between January and July. 
Furthermore, China continues to account, along with the United 
States, for a significant part of growth in the world economy, 
and that is also a plus.
    As you know, I think in one particular area the 
Administration has placed much emphasis on is responding to the 
concerns of the U.S. manufacturing sector. Secretary Evans, in 
March, directed Under Secretary Aldonas and Commerce Department 
staff to review the issues affecting the competitiveness of 
U.S. manufacturing and outline a strategy for addressing them. 
The report on that subject will be released later in the fall.
    In the course of developing this initiative, Commerce 
officials held 20 or so roundtables across the country. And of 
direct relevance to this session, I would note that during the 
roundtable discussions no country raised more attention as a 
source of concern than China.
    Our manufacturers complained about rampant piracy of 
intellectual property, pressure to transfer technology in 
conjunction with their investments, trade barriers, capital 
markets that are largely insulated from free market principles, 
and so forth.
    We have also heard rising concerns more broadly about the 
pace and the direction of China's WTO implementation in areas 
such as transparency, distribution and trading rights, 
services, agriculture, financial services, and so forth.
    To ensure that China honors its commitments and to make 
sure that U.S. companies can take advantage of the 
opportunities that are generated, we at Commerce, working 
closely with our fellow agencies, have adopted an aggressive, 
multi-pronged approach.
    We will, for one thing, continue to target unfair trade 
practices wherever they occur. We are exploring the use of new 
tools to expand our trade promotion efforts with regard to 
China, and we are expanding our efforts to engage Chinese 
officials, I think, in keeping with the spirit of this 
Commission's report, to help make sure they get the rules right 
as they continue to write new laws and regulations in 
restructuring their economy.
    One particular area of concern that I would flag, of 
course, is protection of intellectual property rights. We 
continue to have massive problems in that regard. I think China 
can, and must, do better in that area. We will continue to 
press on that issue.
    One issue raised in the manufacturing roundtables, of 
course, was the issue of the exchange rate of the Chinese yuan. 
I would simply say on that that the Administration believes 
that currency values should be set by free market forces. 
Secretary Snow delivered that message, of course, to the 
Chinese some weeks ago.
    Finally, let me just say we are continuing domestic 
outreach as well to prepare our companies to compete in the 
China market, and we continue to press the Chinese at all 
levels on the issue of market access and compliance. Next up 
for us will be the trip to China of Secretary Evans in October, 
where he will certainly work to ensure that U.S. companies face 
a level playing field in the China market.
    Thank you for devoting this hearing to these issues, and I 
look forward to responding to your questions.
    Thank you.
    [The prepared statement of Mr. Levine appears in the 
appendix.]
    Chairman Leach. Thank you, Mr. Levine.
    Mr. Freeman.

  STATEMENT OF CHARLES W. FREEMAN III, DEPUTY ASSISTANT U.S. 
   TRADE REPRESENTATIVE FOR CHINA, OFFICE OF THE U.S. TRADE 
                 REPRESENTATIVE, WASHINGTON, DC

    Mr. Freeman. Thank you, Mr. Chairman and members of the 
Commission. I have a written statement which I would like to 
submit for the record, if I might, but would like to briefly 
summarize some remarks, then take questions.
    Briefly speaking, it has been 21 months since China has 
been in the WTO. As most of you know, there were two main 
reasons that we were encouraging China into the WTO.
    Number one, because of the market access opportunities that 
were likely to become available in one of the world's fastest 
growing markets, and certainly one of the more intriguing 
markets, but also to provide an independent forum at the WTO in 
which we could mediate trade disputes without resorting to 
unilateral processes, unilateral action.
    The other, sort of on a fundamental philosophical level, 
the reason we wanted to get China into the WTO, was really to 
begin to encourage China to play a greater role in 
international organizations that play by the rules, and in so 
doing to encourage China to play by the rules and, thus, to 
begin to implement more of a rule of law than they previously 
have had.
    As most of you know, China has never traditionally been a 
place governed by the rule of law. There has always been a rule 
of man, as it were, or woman, as the case may be. So, this is 
something relatively new.
    Truth be told, in terms of the 15 years that it took to get 
China into the WTO, the 15 years of very tough negotiations, 
the main thing the Administration has learned, as in the past 
21 months, is that that 15 years was no accident.
    It is extremely tough going in terms of negotiating with 
the Chinese post-accession to make sure that they actually 
fulfill their commitments that we spent 15 years getting them 
to undertake.
    There have been some very notable positives in terms of 
China's implementation. The first year was very much devoted to 
a nuts-and-bolts operation in China of putting the legal regime 
in place to allow for WTO implementation and compliance.
    And I have to say that that process was monumental in terms 
of the sheer number of new laws that they either promulgated, 
passed, or amended in order to get them up to speed with WTO 
implementation.
    As many of us knew, year two, beginning December of last 
year, would be when the rubber met the road. In the last 9 
months or so, we have really started to move beyond sheer nuts-
and-bolts operations into actually trying to make sure that 
China lives up to not only their commitments in the WTO by 
passing the laws, but actually lives up to enforcing the laws 
that they have passed. Again, that has been an occasional rough 
row to hoe.
    I will say that a lot has been going on in China in the 
last 6 months that is non-trade related. They have had a major 
leadership change. They have had a terrifying epidemic in SARS. 
They have had a fairly significant series of protests in Hong 
Kong that have, I think, altered the political landscape 
somewhat.
    And they have gone through the general process of 
dislocations that any rapidly changing economy, especially an 
economy that has gone from a planned to more market-oriented 
economy. These have been challenges. They have not been excuses 
not to implement WTO, in our view.
    And, to the extent that they have been distractions for the 
central government away from implementation efforts, we 
certainly have seen other actors in the Chinese economy step 
forward and try, if not to backslide on WTO commitments, to 
certainly be creative and think outside of the box in ways to 
work around WTO commitments.
    In December 2002, and, again, every year for the next 12 
years, I believe, the Administration publishes a report to 
Congress on China's WTO implementation. Last year, we noted 
four major areas of concern with China's implementation.
    Those were related to agriculture issues, intellectual 
property rights, services, and transparency. Those continue to 
be the main areas of concern, but there has been an additional 
area of concern that we have noticed and that's China's use of 
value added tax policies to skew the competitive landscape for 
their own domestic companies, either by making the playing 
field slightly less than level for our exporters or to 
encourage exports of products that might otherwise not be 
competitive. These are significant areas, and I can get into 
them in detail.
    Agriculture. We have made some steps forward. We have had 
some significant problems with China's imports of soybeans, 
both for genetically modified organism [GMO] reasons and for 
sanitary and phytosanitary [SPS] reasons. We have made some 
significant headway toward that, although we are not completely 
out of the woods yet.
    In terms of soybeans, we did sell a record $1.2 billion 
worth of soybeans in the first 6 months of this year. That is 
an annual record, so we have made some progress there.
    We have had problems with our implementation of tariff rate 
quotas for bulk agricultural commodities, and we pushed hard to 
get those done, again, as a result of our pressure.
    I do not want us pat ourselves on the back quite yet, but 
we certainly have exported a record amount of cotton into China 
in the last 6 months. Again, we are not out of the woods with 
agriculture yet.
    We talk extensively about the other areas of 
implementation. My time is up, I see. But, again, we are deeply 
engaged in pushing these issues forward. We are making 
progress. It is limited, and we are certainly frustrated at 
times.
    We understand the frustrations of our exporters, our 
manufacturers, and our farmers. Our only pledge is that we will 
continue to work, and we do think we will continue to make 
progress, but it is a tough row to hoe. Thanks.
    [The prepared statement of Mr. Freeman appears in the 
appendix.]
    Chairman Leach. Thank you, Mr. Freeman.
    Let me just ask two quick questions. First, to Mr. Levine, 
from the Commerce Department. There is the issue of free and 
fair trade that all of us in American politics deal with 
constantly. Your office is among the principal ones posited 
with the fair trade mandate from the U.S. Government.
    There is one free trade issue, though, that I would like to 
just emphasize again that I spoke to very briefly earlier. That 
is, free trade in currency. It strikes me that commodities are 
not that different from currencies.
    Unless you have a free trade in currency, you have the 
capacity of individual governments to, to use a verb that was 
used earlier, and then also by Mr. Freeman, to skew the 
international landscape of trade.
    I would just like to ask whether your office has made a 
particular effort to speak to the currency issue and the value 
of the RMB.
    Mr. Levine. Having switched the order of our presentations, 

actually I will defer to Charles Freeman from USTR.
    Chairman Leach. Well, I am sorry. We will go to Mr. 
Freeman, but I want to ask this of the Special Trade 
Representatives' Office.
    Mr. Freeman. Yes, that is me.
    Chairman Leach. Oh, that is Mr. Freeman. Yes. Go ahead. I 
apologize.
    Mr. Freeman. I am sorry. I was delayed outside by the 
excellent security here.
    Chairman Leach. I am confused myself here. Go ahead, 
please.
    Mr. Freeman. We understand the seriousness of the issue. We 
have heard manufacturers speak on this issue. As you know, 
Treasury Secretary Snow has been very active and up front with 
the Chinese about the importance to the United States of the 
currency issue.
    As a general matter, the WTO is not what we would consider 
in the ordinary course of business a mechanism to address for 
exchange rate policies. There are other international 
organizations and multilateral organizations that do that. It 
is focused on commodity trade issues, generally.
    That said, we certainly are taking the China currency issue 
very seriously and we are very deeply engaged with both 
Treasury and the rest of the Administration on the issue to 
make sure that what Secretary Snow is doing and what the 
President is doing is carried through.
    Chairman Leach. I appreciate that, although I do not want 
to allow you to simply escape the WTO, because it could be a 
subsidies issue under the WTO. So, it is not exactly a non-WTO 
issue.
    Let me then turn quickly to Mr. Levine, because other 
people have questions, too. I am very concerned with some 
cultural types of issues. We have been working with the 
National Endowment for the Arts [NEA], with Chairman Dana 
Gioia, on the possibility of an artists' exchange and an art 
exchange, with a possible visit--and I do not know if it has 
been firmed up yet--of the Chinese premier to this country.
    I am wondering if the Department is willing to think 
through the prospect of a cultural agreement at that time, and 
have you been thinking that through?
    Mr. Levine. Thank you, Mr. Chairman. I believe the visit of 
the premier is confirmed, and I think the Chinese foreign 
minister, in town yesterday, in fact, made an announcement on 
that visit.
    With regard to the Commerce Department, I would say that I 
am not aware that we have been looking at the cultural area and 
cultural agreements.
    I will say that, from my career, having served in China 
several times and seen the cultural differences and 
misunderstandings, I strongly understand the importance of 
those kinds of activities. We certainly would be happy to talk 
with the other agencies involved, the State Department and 
others, and see what the status on that issue is.
    Chairman Leach. Very good.
    Sandy.
    Representative Levin. Thank you. Thank you for your 
testimony.
    Let me follow up, Mr. Chairman, on your question about 
currency, and then I want to go on to others. Mr. Freeman, I am 
not sure that your answer is going to satisfy those who are 
concerned because, as you know, article 15 of the General 
Agreement on Tariffs and Trade [GATT]--and it is in my opening 
statement that has been submitted for the record--paragraph 4 
prohibits WTO members from using exchange action to ``frustrate 
the intent of the provisions of GATT/WTO.'' That leaves open 
the possibility of our country using one or another mechanism, 
including a possible section 301 effort.
    I want the Administration to know that the visit of the 
Secretary did not really satisfy the concerns, I think, of 
anybody. Indeed, that applies not only to China, but to Japan.
    Japan has been using huge amounts of its currency to buy 
huge amounts of dollars. That is very open. The purpose of it 
is very clear. It has a clear trade impact and purpose, and it 
is not a stretch to say the same is true of the Chinese 
position on its currency.
    So, our office has been looking at article 15.4, and 
provisions including section 301, and I think the 
Administration needs to do the same.
    Let me ask you another question, and then maybe you can 
comment on both. The proposal that Mr. Bereuter and I put 
together some years ago now called for the creation of this 
Commission, but it also created or asked that there be created 
an annual review. That is covered by your testimony.
    This is on page 4, I think, the transitional review 
mechanism [TRM]. You say there that ``the first year of the TRM 
was marked by some misunderstanding between China and other 
members as to expectations of China at the TRM, but 
communication clearly improved. The Administration expects a 
smoother and more useful transitional review mechanism effort 
in year two.''
    I just want to underline for you how important we 
consider--I think the entire Congress considers--the effective 
use of that annual review.
    China's admission into WTO was a much more major event than 
the accession of many other countries because of the size of 
its economy and its size overall. Many of us were not happy 
with the diligence, the effort that went into making that 
meaningful the first year.
    So, quickly, let me ask you about one specific example of 
where China is not living up to its obligations, auto 
financing. The language was very clear in the agreement that 
was reached between China and the United States, and that meant 
between China and everybody else. It was part of its accession.
    I do not know if you are familiar with that specific 
aspect. If you are, quickly comment on it. It is one example of 
China's failure to follow through with its commitment.
    Mr. Freeman. Thank you, Congressman Levin. Taking your 
issues in turn, the Administration does not have a position 
currently on section 301 action, that that might or might not 
take place with respect to currency. I am very happy to work 
with your staff on comparing notes on how article 15 might be 
employed.
    Representative Levin. Your offer is accepted.
    Mr. Freeman. Very good.
    In terms of the importance of the TRM, we agree that it is 
a very important process. One of the issues, the main problem 
that we had last year with the TRM in terms of trying to make 
sure that China understood how important it was, was that China 
kept claiming that the TRM was a discriminatory process, that 
somehow they were being singled out for discrimination within 
the WTO for special examination.
    What we kept saying to China is, look, you got in under 
very particular circumstances. Most WTO members, when they are 
accepted, actually have to implement commitments in order to be 
WTO members.
    Because you are such an important and unique economy, you 
were allowed in simply by promising to implement these 
commitments. So the TRM is the WTO's way of back-checking to 
make sure you are living up to those commitments.
    I think, over time, that became increasingly clear. By the 
end of last year, we actually had Vice Minister Long say to us, 
``The more we think about it, the more we realize this is 
actually a very useful exercise for us. For years we were 
paying Jeffrey Sachs and others to come into our economy and 
tell us what we needed to do to implement reforms. Now we just 
go to the WTO and you tell us what is wrong so we can implement 
it.'' Whether or not you actually believe that as a result they 
will implement it is another question, but at least we are now 
on a path where we have a better understanding. So, we 
anticipate it will be a bit smoother this year. We certainly 
are not giving up on the process, I will tell you that.
    In terms of auto finance, again, this is something that, as 
you probably know, we have been very forceful with China on for 
quite some time. They did promise that they would set in motion 
a process to create a market for auto finance, and it is 21 
months and we are still not there yet. I was there in June. 
They told us they had their regulation ready to go and that it 
will be ready in October. So, we are waiting for October.
    Again, what we have done, is they have released draft rules 
on how to finance. We have commented. They have changed the 
rules. And one of the things that they say to us is, ``Well, we 
are trying to get these out, but you guys will not let us.''
    We said, ``Well, they have got to be right. You cannot just 
put out any auto finance regulations. They have got to actually 
make commercial sense.'' And, to date, they have not. So, we 
anticipate that the latest round of rules that they will be 
putting out will be better. Will they satisfy all of the 
interests of our constituencies and your constituencies? Maybe 
not. Maybe not. But we certainly are making progress.
    Representative Levin. All right. Remember, the TRM, the 
second one, is up next month, right?
    Mr. Freeman. Actually, what has happened is, there are 16 
different meetings of the WTO subsidiary bodies. In fact, the 
Committee on Agriculture meets tomorrow morning in Geneva and 
does the TRM there.
    What we have done, is we have submitted a series of 
questions to the Chinese. They have got a delegation from 
Beijing and Geneva that is there to address agricultural 
issues, both bilaterally and in the WTO.
    Representative Levin. Thank you.
    Chairman Leach. Mr. Bereuter.
    Representative Bereuter. Thank you, Mr. Chairman.
    Thank you, gentlemen, for your testimony.
    In our second panel, Gary Martin, president and CEO of the 
North American Export Grain Association will present his 
testimony. Mr. Freeman, I would hope that you would have a 
chance, with other members of the USTR, to look carefully at 
it.
    It talks about the situation we face today with respect to 
our agricultural exports--uncertainty regarding biotech 
regulations, issuance of permanent safety certificates for 
biotech products, labeling and information requirements on meat 
and poultry products that increase export costs without 
enhancing food safety, and finally the lack of Chinese 
adherence to the agreement on the application of sanitary and 
phytosanitary measures.
    All of these things seem to put us at a substantial 
disadvantage until we have progress in those areas on this 
particular sector for export base. I do not know if you have 
any reaction to that, but I think those are significant 
problems that need to be addressed.
    Mr. Freeman. Congressman Bereuter, thanks very much. As Mr. 
Martin and others know, agriculture has been one of our abiding 
concerns and abiding focuses of the Administration since 
December 2001. All of those issues that you raised are right at 
the top of our agenda.
    On biotech issues, we are waiting for the permanent safety 
certificates to be issued. They have extended the interim 
regulations until April 2004. But, again, we are waiting for 
the final shoe to drop there.
    The labeling requirements, again, are a continued problem 
that we have been pushing. It is not simply a problem of 
labeling. It is that the labeling is so inconsistent, so it is 
hard to actually put your thumb on it. SPS regulations are a 
continued bane. We just had four soybean shippers that were 
threatened with a ban on their exports for alleged SPS issues 
that, in our view, just ``ain't so.''
    So, apparently we have gone into technical talks with them 
on that issue. What they have said is, as long as those 
technical talks are proceeding, they will not implement the 
ban.
    But, again, what all these actions do, is they do create a 
cloud over the marketplace and they do make trade that much 
more difficult. That probably adds some extra cost to our 
exports, and that is something we really want to avoid.
    Representative Bereuter. It does, indeed.
    A week ago today, I had a chance to express my concerns to 
Secretary Evans at a party caucus of the House. My concern 
related to the fact that the European Union, it seems to me, is 
outstripping the United States in dramatic ways with respect to 
their work with the Chinese authorities.
    They are in China and they are assisting, for their own 
benefit, the Chinese to write the standards for manufactured 
products. Those standards oftentimes are not--in fact, usually 
are not--the same as we have in this country.
    Therefore, the long-term impact of their success in working 
with the Chinese is going to dramatically hurt our 
manufacturing base. I think my advice to him is, we cannot 
protect our interest in the Chinese markets on the cheap.
    The USTR is a very lean agency; I hope lean and mean in a 
positive sense. But the Commerce Department, the USDA, and the 
State Department have to be in greater numbers on the scene in 
Beijing and in China, and we do not have enough people to do 
the job in that location.
    The impact is going to be very detrimental in the short 
term and increasingly detrimental. I want to give that message 
to you once more, to the Administration, that you cannot do 
this on the cheap. You have to be there with people that are 
well-trained, and now is the critical time. We do not have any 
time to lose.
    Would you like to respond?
    Mr. Levine. Yes, I would. Thank you.
    With regard to the specific issue of standards, I 
absolutely could not agree more. I know Secretary Evans, of 
course, has attached a tremendous amount of importance on the 
issue of standards. It really is a strategic choke point, in a 
sense.
    If we get the standards issues wrong, as you suggest, if in 
fact the EU or others promulgate standards which effectively 
shut our products out of the market, the results, indeed, would 
be tremendously damaging.
    For that reason, let me just say we have been undertaking a 
very active program at Commerce, and in fact are continuing to 
build on that program. Just this week, the Chinese standards 
organization was in town and signed an MOU with the National 
Institute of Standards and Technology [NIST] for further 
cooperation.
    We have coming up several planned seminars and workshops. 
We are talking with the U.S. private standards development 
organizations about finding a way to increase or to have some 
representation for them actually on the ground in China.
    We are, in a word, trying to make very strong efforts in 
this area, and will continue to do so. I agree completely, this 
really is a critical issue for us.
    Representative Bereuter. Well, as a representative 
concerned about the export base in my own district and State, 
and our national concerns, I could not help but raise these 
issues, these commercial export issues, with you.
    Coming to the mandate of this Commission, in the area of 
corporate social responsibility, we have three particular 
findings. I will just mention two of them very briefly for you 
and the people gathered here.
    The first, contract factories that are not owned by U.S. 
companies produce many of the products that China exports to 
the United States. Many factories that sell nearly all of their 
products to U.S. consumers receive only indirect consumer 
pressure to provide adequate working conditions for their 
employees, directly to human rights kinds of issues.
    Second, despite the good efforts of some U.S. companies 
sourcing from China, current efforts by these companies have 
not significantly improved working conditions in Chinese 
contract factories. These companies are beginning to recognize 
that auditing is not enough to assure acceptable working 
conditions.
    Now, we have to have an impact on what happens in China 
through our American commercial enterprises and the contract 
factories that so most of the work in producing those products 
that they in turn export to us.
    I would hope that we are having the same kind of interest 
on the part of the European Union and Japan, for example, that 
they have that kind of social responsibility, but I am not 
confident that they do.
    I have been told, Mr. Freeman, from what seems to be a 
reliable source, that one-third of the exports from China to 
the United States today are to Wal-Mart. Do you think that is 
within the realm of possibility? By value.
    Mr. Freeman. I have heard similar statistics. I have heard 
that Wal-Mart does import a tremendous amount from China. I 
know that Wal-Mart is also very focused on market access in 
China, and they are one of the fastest growing retail 
operations there. So, there is some two- way trade there, but 
they do a tremendous amount of business there. That is true.
    Representative Bereuter. Well, it must be a very large 
amount. It is a third, perhaps, or maybe more. Somewhere around 
that, I would guess. They are a behemoth in this country in the 
retail sector and are rolling over their competition. They are 
the largest grocer in the country now. You can buy everything 
at Wal-Mart, as you know.
    It seems to me, Mr. Chairman, that if we had an opportunity 
for Wal-Mart to come and talk to us, we could, by influencing 
the policy of one company, dramatically impact the contract 
factors in China and the working conditions in which the 
Chinese work, and also the competitive situation that our own 
producers face in this country.
    I would like to suggest that maybe the place we focus some 
attention on social responsibility is on the giant. If we can 
get good cooperation and movement on their part, it not only 
sets a good model for the rest of the Americans and hopefully 
for the Europeans and Japanese. At least we could get some 
early results if we can convince them that this is an important 
priority they should have, and that the dollar is not 
everything.
    I welcome any final comments you might have on the 
question, but those are the things I wanted to put on the 
record at this point, Mr. Chairman.
    Chairman Leach. Do either of you want to comment further on 
Mr. Bereuter's incredibly thoughtful observations?
    Mr. Levine. I would just add that, on the corporate social 
responsibility side, Secretary Evans, as I think you may know, 
has attached enormous importance, and I think in the context of 
his 
upcoming visit to China we are looking at events, in fact, that 
can highlight his commitment and the U.S. commitment in this 
area. So, that is also something that I know he feels very 
strongly about, and we are working as best we can in that area. 
Thank you.
    Chairman Leach. Ms. Kaptur.
    Senator Levin. Mr. Chairman? Just very quickly.
    Chairman Leach. Yes, Senator. Would that be all right?
    Representative Kaptur. I would be pleased to yield to my 
champion, the Senator from Michigan.
    Chairman Leach. Why do we not do it this way, then. Since 
no Senator has been recognized yet, why do we not recognize 
you, Senator.
    Senator Levin. I do not want to go out of order. I just ask 
you to yield for 1 minute.
    Representative Kaptur. I would be pleased to yield.
    Chairman Leach. Please. Yes, of course.
    Senator Levin. On the report, I am in support.
    Chairman Leach. Thank you.
    Senator Levin. I want to thank the Commission and want to 
express my strong support for including the question of 
currency manipulation by China in our deliberations and to find 
ways to do that in assisting with our mandate. There are ways 
to do it, I believe, in reference to the WTO.
    My brother made reference to Chinese currency manipulation 
in his opening statement, and the impact it has on our exports, 
and that it is a subsidy to Chinese exports. This is an 
important issue that needs to be included as this Commission 
proceeds next year. I want to thank the Chair, and thank you, 
Congresswoman Kaptur, for allowing me to intervene.
    Representative Kaptur. I would yield for you any time.
    Chairman Leach. I would ask the gentleman to yield briefly 
from his intervention and simply stress that I think this is a 
seminal issue in our trade relations. I also think that there 
is a point that has to be stressed from the perspective of the 
U.S. Congress.
    Many in China are saying, what are we doing suggesting a 
precise, new peg for their RMB? I would stress, we are not. 
What we are suggesting is that there ought to be a free trade 
in currency and that the market would determine the value. That 
is different than saying their RMB ought to be revalued 2 
percent, 8 percent, 40 percent. It simply is, let the market 
determine the value.
    I would also stress that, from a manufacturing perspective, 
there are clear and obvious implications. But from a total 
wealth perspective, a strong currency from China's view has 
some real pluses for their society in terms of their capacity 
to buy foreign goods and to buy more of their own goods.
    This is not an effort of an American society that thinks it 
is being totally disadvantaged to achieve something process-
specific, it is simply to press a principle, and the principle 
is free trade and fair trade. That is very different than 
saying a precise, pegged point.
    Senator Levin. I thank the Chairman for that. It is clear 
that what China is doing is manipulating the currency to 
advantage their exports and disadvantage our exports, and that 
is not allowed by the GATT.
    The GATT does not permit, under article 15, WTO members 
from taking action to frustrate the GATT provisions. That is 
what China is doing in pegging its currency the way it does, 
and it is having a severe effect.
    Both management and labor, companies and unions, are 
together in this country, to try to stop China from taking 
these actions and doing that manipulation which so 
disadvantages our exports and advantages their exports. It 
costs us jobs, especially in the manufacturing area, where now 
over 2.5 million manufacturing jobs have been lost in the last 
couple of years.
    So, it is important that we include the issue of Chinese 
currency manipulation in the next report, and find ways to 
include this issue as we discuss the WTO.
    Chairman Leach. Fair enough. At the risk of presumption, I 
want to make a concluding point to emphasize the concern of 
people in other societies and publics. When governments 
intervene to skew their currency, private markets are much 
larger. When inevitable changes occur, it is public treasuries 
that lose sums of money.
    So, if you take the Japanese intervention which your 
brother raised, if there is a movement of the Japanese 
currency, let us say, of a 20 percent direction and the 
Japanese government has intervened to the tune of, let us say, 
$300 billion, the public in Japan loses 20 percent times $300 
billion, which is a $60 billion loss to the public of Japan.
    Japan is moving in this direction, partly because other 
countries have skewed their currency relationships. But it 
causes huge losses of public funds when you have these pegged 
currencies that governments intervene to try to prop up. That 
will inevitably be the case in China.
    Senator Levin. I admire the Chairman's optimism in 
attempting to persuade the public in China and Japan that it is 
not in their interest to do what they are doing. I admire you 
no end for that effort. I had given up on that a long time ago.
    I think it is particularly important that we let them know 
that we are not going to tolerate it. It is not in our 
interests that they be allowed to do what they have been doing 
in China and Japan for such a long time. I would add what I 
think is our principal need, but I must say, again, the 
Chairman is absolutely right, that it is not in their interest, 
ultimately, either.
    But I am not so sure that they are going to see it that 
way. In the meantime, I think we have got to make it clear to 
them what is clearly not in our interest, that they continue to 
do the manipulation that China, Japan, and others have done for 
too long without contest on our part.
    Chairman Leach. As usual, the Senator from Michigan is more 
profound than I am.
    Ms. Kaptur.
    Representative Kaptur. Thank you, Mr. Chairman. Just to 
follow up with an observation. The anemic U.S. growth rate has 
been reduced by a third because of our ongoing and growing 
trade deficits with the world, China now being our leading 
trading--what would we call it--deficit partner, Japan being 
No. 2.
    I remember, as a young, naive Congresswoman coming in here 
21 years ago and being told, ``Oh, Congresswoman, it is only a 
currency problem. At that point, Japan was the leading trading 
partner with the United States. The problem is not that they 
manage their trade, Congresswoman. The problem is the yen. When 
we get the right yen/dollar relationship, we will have a 
balance.'' Wrong. It will not happen because it is not a free 
market with Japan. It is a managed market with Japan. It does 
not matter if it is 150 yen to the dollar or 98. We continue to 
sustain $50 billion trade deficits with that country every 
year, largely in the automotive sector. That is No. 1.
    And, believe me, we have written bills, we have tried to 
get market opening. In 1983, less than 3 percent of Japan's 
market were automobiles or parts from anywhere else in the 
world. In 2003, the same number.
    So you can fiddle around in a side show all you want, but 
in the end the trade deficit is your measure and it has been 
failure, after failure, after failure of this country actually 
moving those balances in our favor.
    Now we face China and, again, a managed trade situation. 
Under your gentlemen's watch, our trade deficit with China has 
doubled. It has doubled. Now, you would not get a passing grade 
of A in any school if those numbers kept going up from the 
standpoint of the people of the United States.
    Now, you can spend all the time in the world concentrating 
on the currency exchange. But let me tell you, when you have 
managed markets, it will not matter because Japan is our model 
of what has happened, and we have continued to erode 
production.
    I guess there is an assumption by some that America will 
just cash out everything: since the year 2003, now, 3 million 
more manufacturing jobs; in the agricultural sector, 50 cents 
of every U.S. farm dollar, now Federal subsidy, only to hold 
the farm credit system together or we would have a collapse 
like the 1930s.
    Something is fundamentally wrong with the trade accounts. 
It is at the highest of policy levels. I was looking at how 
long you gentlemen have served in your current positions, and 
we are very happy that you are there.
    But you are not going to succeed because the fundamental 
policy is wrong. The United States is essentially cashing out 
her wealth. The reciprocal of that trade deficit over 20 years 
is the amount of our public weal.
    The Chairman has talked about the public side, that it is 
now owned by foreign interests, nearly half, with China being 
our largest creditor and Japan No. 2.
    We are paying them interest now. Why would they want to 
reduce their currency exchange with us when they are getting 
pretty good interest rates at the moment? So, we are living on 
borrowed capital. That is all we are doing right now in this 
country.
    I would like to ask you gentlemen a question. In the last 
year, how many times have each of you traveled to China to deal 
with these issues that we are talking about here this morning? 
I am just curious.
    Mr. Freeman. I have been, in the last year, probably five 
times.
    Representative Kaptur. Good.
    Mr. Levine. I just assumed my current portfolio handling 
China and other parts of Asia only 4 months ago, I guess. I 
have made two trips to China in that time, and will be going 
out again next month with Secretary Evans.
    Representative Kaptur. I know those are very wearying 
trips.
    I would like to propose this. I do not know if we do it 
through this group or I do it separately, but here is an 
example.
    Huffy Bicycle had 2,000 people employed in Ohio 
manufacturing the best bicycles America had. Two thousand 
workers who have all now lost their jobs. They earned a living 
wage. Was it the highest wage in the world? No. They had health 
benefits. They produced a fine product.
    That Huffy Bicycle is now being manufactured in China. I 
would like to visit that facility in China with you gentlemen, 
and I would like to take some of the people that used to work 
at that plant in Ohio with us.
    I would like to compare the working conditions of the 
people who now manufacture those bicycles and I would like to 
compare the quality of those bicycles compared to what the 
people in Ohio used to make.
    Those bicycles come back to places like Wal-Mart and K-
Mart. And you know what? The price did not go down. The workers 
in China make about 10 cents an hour. I think it is important 
for American to understand the differential on which certain 
global 
interests are trading.
    They are trading on the exploitation of workers who work 
for starvation wages. They are trading on environmental 
conditions where we are leaving cesspools around the earth. 
There are certain wealthy players in the international realm 
who take great advantage of this situation.
    Until we fly in the face of that, we are never going to 
balance these trade accounts. Meanwhile, jobs across this 
country and the wealth of this country, more than money, but 
the manufacturing and the agricultural wealth, continues to get 
cashed out.
    I really want to go with you. But I do not want to go to 
some abstraction about some currency exchange that is going to 
be changed because we have some kind of belief that the world 
really operates in free markets.
    It does not. We have managed trade. When you have countries 
that follow a managed trade regimen, you get trade deficits. We 
end up being the dump market of the world, and shame on us.
    We also do not make lasting friends around the earth. So, 
to me these trade deficits are unsustainable. I really want to 
go with you, but I want to take the people from my area. Let us 
look at this right in the eye. This Commission is a way to do 
that. Congressman Levin asked for something more tangible. Let 
us make it more tangible.
    I wanted to ask a question. That is, do you believe that 
the trade deficits that we are now experiencing with China are 
sustainable for the health of this economy inside the 
boundaries of the United States?
    Mr. Freeman. Well, Congresswoman, thank you for that. On 
the question of going to China, I think that would be very 
useful, for a couple of reasons.
    Representative Kaptur. Great.
    Mr. Freeman. First of all, I think not only would it be 
useful for your trip and the trip with former workers at Huffy 
to see the conditions there, it also would be very useful for 
the workers in China to exchange views and know what they are 
missing out on, perhaps. So, I think it would be a very useful 
trip and I would be happy to recommend to Ambassador Zoellick 
that that trip take place.
    Representative Kaptur. Thank you.
    Mr. Freeman. With respect to the trade deficit question, I 
am not an economist. I am just a humble market access person. I 
will say that, in terms of the deficit with China, it is the 
largest growing percentage of our overall deficit. It is about 
22 percent of our overall $463 billion deficit.
    But it is slightly confusing, because one of the problems 
is that a lot of the things that we used to buy from places 
like Indonesia, Malaysia, and Thailand have shifted to China. 
So, actually, China's deficit has increased, while the deficits 
from those other places have come down.
    The other problem is that our deficit has increased 
recently because our exports have come way down. About half the 
new growth in deficits has resulted from our exports having 
decreased. Interestingly, that is not the case with China. 
While our exports to the rest of the world have decreased about 
8 percent, in the last few years exports to China have 
increased about 65 percent. China is our fastest growing 
market.
    So, the growth in the deficit with China is certainly 
something that we are particularly focused on and concerned 
about, but there are other issues that are at play. One is that 
China is taking up a new share all on its own of the overall 
deficit. So, again, it is a complicated issue. But I think the 
fundamental thing that we would like to get to, is to make sure 
that the playing field is fair.
    Chairman Leach. If I could interrupt, briefly. We have a 
vote on the House floor. We have about 10 minutes left on the 
vote on the defense appropriations conference report. I think 
we are obligated to recess, with the exception of the Senate 
members. Senator, would you like to continue?
    Senator Dorgan. Mr. Chairman, I would.
    Chairman Leach. Would that be all right with you, Marcy? 
Then we will return to you when we come back.
    Senator Dorgan. Mr. Chairman, if you do not mind, let me 
inquire. We have Secretary Rumsfeld downstairs in the 
Appropriations Committee.
    Chairman Leach. Sure.
    Senator Dorgan. Let me inquire for a few minutes, and then 
I will put it in recess.
    Chairman Leach. I think that would be very appropriate.
    Senator Dorgan. Thank you very much.
    Chairman Leach. Then we will put you in full charge, and 
then recess and we will return. Thank you.
    Senator Dorgan. I had forgotten how much I admire the 
passion of Congresswoman Kaptur, I must say, before she leaves. 
The passion on this issue is very important.
    I regret that you will miss my questions, Mr. Chairman, and 
the answers from Mr. Freeman and Mr. Levine. But I will try to 
make notes.
    First of all, let me thank both of you for your service. I 
appreciate people coming to public service and offering 
themselves for public service. I know that you work in an area 
that is very important to this country.
    I share some of the same concerns that Congresswoman Kaptur 
does. I think our trade policy is a colossal mess, getting 
worse, not better. Much, much worse. I see things happening in 
international trade that make no sense at all. I will describe 
just a couple of them. I do want to ask you a couple of 
questions.
    The China situation is very interesting to me because I was 
on the House Ways and Means Committee many years ago. I believe 
our deficit with China then was about $10 billion a year. I 
told my colleagues who were pushing a policy, this is going to 
explode on us. Indeed, it has. There was a $103 billion deficit 
last year with China.
    I come at this from the standpoint of, particularly, 
agriculture, but I am very concerned about manufacturing jobs 
and the export of jobs from our country.
    Let me ask a couple of questions. Mr. Freeman, you would 
expect I will ask questions about wheat. We produce a great 
deal of wheat. It was not too long ago, a couple of decades 
ago, we were selling $500 million worth of wheat in a year to 
China. Now it is 1/20th of that, $25 million.
    What I want to ask you about specifically is, my 
frustration is, we never taken action. We do not have a 
backbone. We do not have the nerve, the will, to stand up and 
say, this is wrong and we are going to fight for the right 
result. We just do not do it. We are sort of squishy on all 
these issues.
    There was a fellow named Bruce Quinn who left USTR. He was 
an associate of yours who, on March 17th of this year, was 
speaking at a wheat industry meeting. There was a reporter 
there, and the reporter reported what he said.
    In an explosive fit of candor, Mr. Quinn said that the 
Trade Policy Review Group in this Administration, which 
includes all the major Federal agencies involved in these 
issues, had given the USTR the ``green light'' to proceed with 
a case against China for blocking sales of U.S. wheat to China.
    So, someone from USTR, 1 week before he left USTR--now, 
that is an important point. He was actually leaving, going to 
go out the door, and in a fit of candor told the wheat industry 
meeting that the Trade Policy Review Group had given a ``green 
light'' to USTR to file a trade action against China for 
blocking the sales of U.S. wheat. What he said was that USTR 
was deciding not to do that because it was thought this would 
be an ``in-your-face'' thing to do to China.
    I wrote to every one of the Federal agencies that belonged 
to the Trade Policy Review Group and asked them, ``Is this the 
case? Did you, in fact, as a Trade Policy Review Group, give 
the green light to USTR to take action against China with 
respect to blocking wheat sales? ''
    They all wrote back. No one denied giving the green light. 
Some outright, in fact, said they had done so. If I showed you 
the letters, it is kind of a mishmash of wonderful comments.
    But it appears to me that someone had decided at some point 
in the Trade Policy Review Group to take action here, and the 
Trade Policy Review Group had actually said, here is the green 
light, take action against China for blocking wheat sales. No 
action was taken.
    Can you give me some background on that? Was there, in 
fact, that discussion? Was there a decision that the green 
light was given to USTR to take action? If so, why was action 
not taken against China for blocking U.S. wheat sales to China?
    Mr. Freeman. Senator, thanks very much. If my buddy Bruce 
were here to respond, I am sure he would. Bruce Quinn left our 
office. He is actually a Commerce employee. He is now stationed 
in Chennai--formerly Madras. He's the senior commercial officer 
there.
    What he said, basically--well, I will not paraphrase what 
he said, but let me tell you what essentially happened. TRQs. 
Tariff rate quotas. China, for some time now, has not 
implemented the system of tariff rate quotas to the extent that 
we think they ought to have. Tariff rate quotas cover a variety 
of things, cotton, corn, soybean oil, and wheat.
    One of the issues was that we have had four problems with 
tariff rate quotas with China, four problems with China's 
administration of tariff rate quotas. First of all, they have a 
catch-22 licensing situation. You need to have a contract in 
order to get a tariff rate quota allocation, but you cannot get 
a tariff rate quota allocation unless you have a contract. 
There is a real lack of transparency.
    When they do allocate a TRQ, we do not know who is getting 
it, so it is very difficult for our traders to find out who has 
got the right to buy wheat, corn, or whatever it might be.
    There also was a subquota for processing trade, which, in 
other words, meant that part of the tariff rate quota that was 
set aside had to be processed, which, in our view, did not 
conform with WTO standards.
    Finally, they were allocating tariff rate quotas in very 
small numbers, 2 or 3 metric tons, which, if you know, trying 
to ship 2 or 3 metric tons to China does not make commercial 
sense. The cost does not make sense.
    So what we did is that Al Johnson, who is our chief 
agricultural negotiator, Ambassador Zoellick, and others got 
together with Secretary Veneman and said, ``We have been 
pushing this issue for a while. We are ready to go. We want to 
push forward on this, and we are looking at a WTO option 
here.''
    But, as you know, like any legal process, WTO action is not 
a magic bullet. It takes time to resolve. While you are going 
through the process, how much wheat are you selling? How much 
cotton are you selling? How much corn are you selling?
    So the question is, ``Can we work out with China 
bilaterally a resolution to these issues or are we forced to go 
directly to the WTO? Are we going to say, the heck with it, let 
us go forward? ''
    The issue was that the Trade Policy Review Group got 
together and said, ``Look, Ambassador Johnson, if you cannot 
work it out with the Chinese, go for it.'' Ambassador Johnson 
went to China. I went with him. We worked it out.
    We have got two of our key issues resolved. We have got a 
third they said they have resolved, and a fourth they say that 
you will see that it is resolved by January when we allocate 
quota for 2004. So, right now, again, out of the process of 
doing that, we have sold a heck of a lot of cotton this year.
    Now, wheat, as you probably know, has been relatively high 
priced in this country for the last year or so because of 
conditions, and in China the price has been relatively low.
    Senator Dorgan. Well, you do not own a farm then if you 
think wheat is high-priced.
    Mr. Freeman. No, I know. I understand. But the issue is 
that the market price in China has been relatively low. This 
year, it is going to be high. So, now we can see whether they 
are actually going to implement on wheat, and that is going to 
be the key thing for us in January.
    Senator Dorgan. But the Chinese Government, I understand, 
has decided that only 10 percent of the licenses are available 
to private importers, 90 percent reserved for the Chinese 
Government, about. Therefore, the Chinese Government decides 
whether they will or will not buy American wheat. Is that not 
correct?
    Mr. Freeman. There is a certain percentage that has been 
reserved for State traders.
    Senator Dorgan. Is it 90 percent?
    Mr. Freeman. I do not know what the exact number is. I 
certainly can get it for you.
    Senator Dorgan. Well, I am told it is 90 percent.
    Mr. Freeman. I can get it for you.
    Senator Dorgan. That is more than a certain percent.
    Mr. Freeman. I can figure it out.
    Senator Dorgan. Well, let me ask this. We did the bilateral 
with China, and as you know we did not vote on that. Had we 
been able to vote on it, I certainly would have voted ``no,'' 
for many reasons.
    I will give you automobile trade, just for one. Our 
negotiators, whoever they were, sat down and said to the 
Chinese, after a long phase-in we will agree to have a tariff 
on U.S. cars going to China that is 10 times higher than we 
would have as a tariff on Chinese cars into the U.S. market.
    I do not have the foggiest idea, when you have a $100 
billion trade deficit with a country, how you sit down and 
decide that, on auto trade, they should have a tariff that is 
10 times higher and sanction that in a bilateral.
    I think it is incompetent. I do not know who negotiated 
that, but I think it is fundamentally incompetent. Aside from 
that, when we did the bilateral, with respect to wheat, there 
was established an 8.5 million metric ton TRQ level.
    There was this euphoria by some. Not me. What a wonderful 
opportunity to ship wheat to China. Then the agriculture 
minister of China went to Guangzhou, and then the South China 
Morning Post had this to say. The minister said, ``You know 
that 8.5 million metric tons? That is just theory. It does not 
mean that is what is going to happen here.''
    It seems to me that if you follow the trail of evidence, 
that you come to an inescapable conclusion that even Inspector 
Clouseau could reach here, that the trade with China is 
fundamentally unfair and ought to require us to take action.
    I understand your point, Mr. Freeman. You say, ``Well, we 
could take action, but of what value would that be if we are 
still negotiating? '' My question is why are we negotiating in 
the immediate shadow of having reached an agreement? One would 
expect, with a country like China in which we are a cash cow 
for China's hard currency needs with this huge imbalance of 
trade, one would expect that, when we reach a bilateral, you 
would not have to, 6 months, 12 months, or 18 months later 
worry about whether there is compliance. You would, by God, 
expect there is compliance.
    So, on behalf of wheat farmers, I would just say to you, if 
somebody has been given the green light to go take action 
against China on behalf of our wheat farmers, I want you to 
stand up and take action on behalf of our wheat farmers and say 
to China, you have an obligation to let wheat into China. You 
have an obligation to buy our wheat.
    So you say, well, our wheat is expensive. I will tell you, 
the price of wheat is not anywhere close to being expensive if 
you are raising it and selling it. It does not meet the cost of 
production.
    I do not want to hear the Chinese tell us that we have 
expensive wheat. That is nonsense. We have a lot of wheat they 
ought to be buying, and they are not buying it because they 
explicitly, in my judgment, want to keep it out of the Chinese 
marketplace.
    And if they want to ship us all their trinkets and their 
trousers and their tennis shoes and their shirts, good for 
them. But our market ought to be a sponge for other goods from 
other countries only if their market is open to us, and only if 
trade is fair.
    Frankly, our farmers understand that trade with China is 
not fair because they are keeping our wheat out. I really want 
you to file an action, take action. You are saying to me, I 
think, today, Mr. Freeman, that we will see the final result of 
these negotiations by January.
    But I will tell you something, both on the Ways and Means 
Committee in the House and also in the Commerce Committee here 
in the Senate, for, I guess, now, 20 years, I have been hearing 
people promise that it will be next January, or next month, or 
next week, or just over the next hill, or just around the next 
curve, that somebody is going to see some of the good happen on 
behalf of American producers. But nothing good has happened 
with respect to China.
    I will make one other point. I do not mean for this to be 
painful for you to listen to. You indicated that China is our 
fastest growing market, but that is a statistic that is almost 
irrelevant. That is like me saying, on average, Bill Gates and 
I are worth $32 billion between the two of us. So what? Is it 
true? Sure, probably. But I have nothing.
    The fastest growing market? Take a look at the imbalance 
and take a look at the sector-by-sector analysis, and then 
understand the passion of my colleague, Congresswoman Kaptur, 
whose Huffy bicycles are not produced in this country, they are 
produced elsewhere. Why? Because of free trade? Absolutely not. 
Because of other sets of circumstances that create what we 
think is a fundamental unfairness in our marketplace.
    So, let me come back and say that I want both of you to 
succeed. This is not a criticism of this Administration. You 
could put a blindfold on and listen to the murmurs of Trade 
Representative officials from Democrat and Republican 
administrations for 20 years and you could not tell which 
administration was speaking, with one single exception, and 
that was a momentary lapse during Mickey Kantor's term when we 
slapped TRQs on Canada and had a significant impact on some 
grain issues with Canada. Otherwise, it all sounds the same. 
Meanwhile, the problem gets worse and worse and worse.
    So, having said all that, which is extraordinarily 
therapeutic for me this early in the day, I want to ask you to 
be willing to take action. We have trade dispute resolutions 
for a very specific reason.
    That is, when somebody is not complying, then we have a 
right. We have a right to go after them and say, ``Our market 
is open to you, but your market must be open to us, and it is 
not. Sell your trinkets in Zambia.''
    Well, you might want to respond to some of that. But are 
you willing to take some action next week? [Laughter.]
    Mr. Freeman. I am going to demur on that. I will say that I 
do not think that there is any reticence about taking action in 
the Administration. The idea, though, of course, is to make 
progress. While I can tell you, having gone through my own 
share of frustrations, that it would be somewhat therapeutic 
for me to take it next week, too.
    But I will say that your passion and leadership on this is 
well known, not only within the Administration, but in China. 
Your voice is something that China needs to hear, too.
    I have had conversations with your staff at some point 
about the usefulness of your taking a group of wheat farmers 
from your state or elsewhere and making sure that the Chinese 
understand how important it is, not just for the 
Administration, but to wheat farmers and to the Senator from 
North Dakota to actually buy North Dakota wheat. I think that 
is a message that they need to hear.
    Senator Dorgan. Yes. Well, I will take farmers to China if 
we go on a boat filled with wheat. [Laughter.]
    And you promise, that they will buy it when we get there. I 
will take farmers to China, but only to sell wheat.
    Mr. Freeman. I will see what I can do. [Laughter.]
    Senator Dorgan. I took a farmer to the Canadian border 1 
day in a 12-year-old orange truck, and we could not get 200 
bushels of durham into Canada. All the way to the border, we 
were met by 18-wheelers hauling Canadian grain south. So, we 
are a little sore about some of these one-way trade agreements,
    And I will certainly take you up on your offer, but we want 
that offer to include wheat moving to China in significant 
quantities.
    Well, Mr. Freeman, I want both you and Mr. Levine to 
succeed.
    One other question. Market access compliance. That is you, 
Mr. Levine? Both of you?
    Mr. Levine. We share the responsibility, I would say. It is 
in the title of my position, actually.
    Senator Dorgan. You are with USTR and you are with 
Commerce. We have Commerce/State/Justice appropriations coming 
to the floor, and I am fiendishly working on how I might 
improve that for you all.
    Can you tell me how many in Commerce, working on market 
access compliance, are tasked with the issue of dealing with 
China, specifically China? How many people are involved in 
dealing with the China trade issue?
    Mr. Levine. Yes, Senator. In fact, it is a number that has 
grown substantially over the last, I guess it is, 5 or so 
years. Our China office in the market access and compliance 
part of Commerce has grown from 7 staff to a total of 18 today.
    In addition, of course, within China itself we have 
something in excess of 90 Commerce Department staff. That 
includes the Commercial Service, with a strong trade promotion 
focus.
    Included in that number we have two market access officers 
based at our Embassy in Beijing. These are both American 
lawyers hired out of the private sector. They have extensive 
experience representing U.S. companies in China. They both 
speak Chinese. They are working full-time at our Embassy in 
support of market access.
    Senator Dorgan. You talked about promoting trade. My 
interest is in requiring compliance. So are you mixing the two 
with respect to these 18 people?
    Mr. Levine. No. The 18 people are market access and 
compliance, yes, then the two at our Embassy in Beijing as 
well, supported by Chinese employees.
    Senator Dorgan. How many of those 18 are stationed here in 
Washington?
    Mr. Levine. All of the 18 are here in Washington, plus we 
have two focused 100 percent on market access and compliance at 
our Embassy in Beijing.
    Senator Dorgan. In fact, my colleague has returned from the 
House. Let me just finish. I know others will return in a 
moment. But I am going to be dealing with this issue on the 
floor during the Commerce/State/Justice appropriations process. 
We have grown from 7 to 18.
    In fact, if you take a look at China, Japan, Europe, 
Canada, Mexico, Korea, which are major areas of, I think, 
significant trade challenges, I think we dramatically underfund 
the resources that are necessary to really deal with market 
access compliance and enforcement of trade laws.
    Now, it does not pay to have much of our resources devoted 
to enforcement if nobody is willing to enforce anything, if we 
are just going to all sit around and play cards and sip warm 
tea and talk soothing things about how wonderful we all are.
    It does not mean anything to me. What means something to me 
is if we are going to ask other countries to live up to their 
obligations in international trade. We never have. There has 
been no evidence that that has ever been a priority.
    Well, I have had some really interesting opportunities to 
spend some time. You went all the way to the U.S. House and 
back again? Time flies when you are enjoying it.
    Let me thank both of you for being here. I will pursue this 
further.
    Chairman Leach. Senator, I will tell you, one of the 
longest distances in America is between the U.S. Senate and the 
U.S. House. [Laughter.]
    Senator Dorgan. Especially now.
    Chairman Leach. We have managed to return, and we are very 
appreciative of your hospitality on these shores. If you want 
more time, you are welcome to have it.
    Senator Dorgan. I thought you were talking about the 
construction, but you were actually talking about elections.
    Chairman Leach. No, I am talking about the ethereal 
psychological distances that have to be traversed. [Laughter.]
    Senator Dorgan. We are like one. [Laughter.]
    Chairman Leach. But we are observers, and as observers, we 
want you to know we are very impressed with your career, sir. 
Thank you.
    Ms. Kaptur, you were in the middle of your questions.
    Representative Kaptur. Yes, Mr. Chairman. I am sorry I 
missed Senator Dorgan's questioning. I know I would have been 
enlightened by it.
    I wanted to continue with a line of questioning on how much 
trade deficit for the United States is sustainable, with China 
or with any country, indeed. As you look toward the next year, 
what are your goals to reduce the deficit?
    Do you have a target, an Administration target to move this 
trade deficit down? Do you have specific targets? I would be 
very interested in that.
    Then I wanted to ask either of you gentlemen, do you view 
China as a democratic country? Then, finally, what is the 
average wage in the manufacturing and in the agricultural 
sector in China?
    Mr. Levine. I will follow up and respond further, 
Representative Kaptur. Let me say, first, I am not aware of an 
Administration target in terms of the deficit. Again, certainly 
our focus remains on making sure that China complies with its 
commitments, that we remove market access barriers so we can 
increase our exports and, further, take the steps necessary to 
enforce our trade laws and deal with unfairly traded imports 
from China.
    So, in terms of the policy thrust we are very much focused 
on that, but I am not aware of any particular target on the 
deficit.
    If I could actually back up for one moment to your earlier 
comments and say, first of all, that I would be delighted also 
to help facilitate and go along on your visit.
    I will say that, in a previous incarnation as the U.S. 
Consul General in Shanghai, I had the pleasure of arranging a 
visit--this goes back a couple of years now--by Senators 
Lautenberg and Harkin to a contract apparel factory located 
outside of Shanghai. Again, I think that was worthwhile, and I 
would be delighted again to work on this effort as well.
    Representative Kaptur. Thank you. I really appreciate that. 
I am sure some of my colleagues would have similar interests.
    Mr. Levine. With regard to the question, no, China is not a 
democratic country by any means. It is not a democracy. With 
regard to the average wage numbers, I think I would have to get 
back to you with the specifics on that.
    Representative Kaptur. Do you have a feel for it? Is it 
over a dollar an hour?
    Mr. Levine. I have heard sort of varying numbers in 
different parts of the country and so forth. Certainly, it is a 
fraction of comparable wages here in the United States in any 
comparable job. I would feel better about getting back to you 
with really some more solid data.
    Representative Kaptur. I really thank you for that. I 
notice that, in terms of U.S. exports to China, certain 
machinery and electrical goods are gaining in ascendancy. I 
would like to posit the theory, as we look at what has happened 
in other places, those are the machines to manufacture the 
goods that will then displace more jobs here in the United 
States. It is an intermediary step that occurs in the 
displacement process.
    Yes, Mr. Freeman? Did you want to comment on the 
sustainability of this level of trade deficit, whether you are 
aware of whether USTR has a goal for this year to reduce the 
trade deficit with China?
    Mr. Freeman. We do not have a numeric target, at least that 
I am aware of. Again, I think I will leave it to the economists 
to decide what is sustainable and what is not. I am just not 
qualified to comment.
    Again, our focus is market access, making sure that we 
increase both the openness of China's market and that China 
plays by the rules in international trade, and hope that, 
through the combination of that, that that will take care of 
issues like deficits, and so forth.
    I do not know what the average wage is. As Mr. Levine was 
suggesting, there are different parts of China that have 
radically different standards of living. The coast is 
increasingly a wealthier part of the country and, therefore, 
has a higher standard of living. The internal part of China is 
extraordinarily poor, where I think a dollar a day is probably 
significantly more than the average wage.
    Representative Kaptur. Would you guess that a third or more 
of the exports to the United States come from the Guangdong 
Province area?
    Mr. Freeman. It is up there, yes. Shanghai is probably 
close.
    Mr. Levine. I think it is possible, from that area. Again, 
I think we would be probably better served, and you would be 
better served, if we really take a hard look and get you solid 
data.
    My recollection was that, at one time, almost 40 percent of 
China's exports were coming out of the southern part of China, 
including Guangdong Province. But, as I say, we would be happy 
to update those statistics and get back to you with some solid 
numbers.
    Representative Kaptur. I thank you very much for that.
    Mr. Freeman, do you believe China is a democratic country?
    Mr. Freeman. No, China is the farthest thing from a 
democratic country. I am sure it will be some time before they 
do become democratic.
    Representative Kaptur. Mr. Chairman, if you would just let 
me close with this comment. As we watch the fall of the Soviet 
Union and the transformation of internal economies in Russia, 
Ukraine, Belarus, et cetera, it has been very interesting to 
watch the politics and the economics proceed.
    I think one of my concerns with a country that is 
undemocratic is, as Wal-Mart, as Mr. Bereuter referenced, 
conducts business in China, whom are we empowering economically 
and what connection does that have to the politics?
    When you put aside politics as an important ingredient in 
relationships and you concentrate only on economics, what kind 
of a world are you really producing? So, I do have some 
questions in my own mind as to who, politically and 
economically, we are empowering inside China, an undemocratic 
country.
    As people purchase goods in the United States and those 
dollars flow back to Chinese interests, whom are we empowering 
and what kind of system will we bequeath to our children and 
grandchildren? It is a question I would let hang out there, but 
a deep concern.
    We thank you very much for your appearance today.
    Mr. Chairman, thank you so much for allowing me to complete 
my questioning.
    Chairman Leach. Well, thank you very much, Ms. Kaptur.
    Mr. Wolf, do you have any questions?
    Representative Wolf. I want to follow up. We cannot sustain 
it. The National Association of Manufacturers [NAM] has 
predicted that the trade deficit with China will be roughly, I 
think--well, I do not want to say a figure that is not 
accurate. They have been by to see me.
    I think they said it would be roughly $600 billion, and the 
deficit with trade with China in 2005 or 2006--I will submit it 
for the record--would be something like $430 billion. We cannot 
sustain that. I mean, no country has ever, every sustained 
that.
    Two, I was glad to see you say that it is not a democracy. 
It is not.
    [The information follows:]

    The National Association of Manufacturers has predicted 
that next year--2004--the deficit will be $125 billion and will 
increase to $330 billion in 5 years.

    Representative Wolf. I wanted to ask you a couple of 
questions. Following up on what Ms. Kaptur said, would you give 
us within the next week, because this thing has been on my 
mind--and I listened to an interview with a woman in China. Her 
salary was $17 a month. She worked six days a week, 12 hours a 
day. One lady who was the supervisor, or the boss, if you will, 
was making $27 a month.
    So, could you give us, both of you, maybe, a side-by-side, 
hourly wages, wage-an-hour, overtime, EPA. Just take everything 
that our people have to go with, EPA, family leave, the number 
of vacations, and then compare it with what China has. Because 
there have been a lot of stories, and I think Ms. Kaptur is 
right. When I heard her interviewed, I thought the salary was 
higher, but she felt that she was doing very well at $17 a 
month.
    She talked about the conditions, and this being much better 
than she would have ever expected. Yet, at $17 a month, that is 
probably about an hour and a half for a Wrangler jeans 
manufacturer somewhere down in southern Virginia. I think they 
made $10.50, $11 an hour.
    So, if we could get that side-by-side, perhaps by the end 
of the week on all of the issues, health care, anything and 
everything an American manufacturer has to do in comparison.
    The only other question that I have is, and I want to thank 
the Administration for it. It looks like you are finally 
catching the vision about how serious this is. For a long 
period of time, I think the Administration was not focusing.
    But with the job loss, and I think Secretary Evans' speech 
in Detroit the other day, and the comments and relationships 
that we have had with the Department, both of your departments 
over the last couple of days, I do want to thank you for the 
fact that I think you now understand this problem and are 
aggressively being involved in it and trying to reverse it.
    If China were to comply in an honest, ethical, moral, 
decent way by the objective man test to the WTO, what 
percentage of the problem would go away?
    Mr. Freeman. I do not even want to hazard a guess there. I 
think what you would see, is you would start to see a reversal 
of fortune here. Not a complete reversal of fortune, but I 
think you would see the growth at least slowed in the deficit 
and probably reversed.
    Representative Wolf. Has anyone, from a scholarly basis, 
done a piece objectively saying where China was not in 
compliance? I mean, we know there are so many cases. It just 
goes on and on and on.
    Mr. Freeman. I do not think there has been one 
comprehensive academic study of non-compliance. There have been 
some in the area of agriculture. To be quite frank, I think the 
report that we do to Congress every year is probably about as 
comprehensive a survey of China's compliance as we would get.
    Representative Wolf. In the State/Commerce/Justice bill, we 
are setting up what we call Team B. Ronald Reagan, during the 
days of the Soviet Union, set up a Team B to challenge Team A, 
if you will, on the strength of the Soviet Union.
    We are trying to set up a mechanism where GAO and others 
can--I think the more you are pulling in people from outside to 
test you, to make sure that what you are doing is exactly 
accurate, because there is a lot of talent out there, and I do 
not think the Administration ought to feel funny about taking 
advice from people outside. But I think the more you are going 
outside, particularly with the mood shifting in a country, the 
better it would be.
    I guess, if you could maybe just submit for the Commission 
in a summary form some of the areas that you believe that China 
is not in compliance with the WTO, and major areas that, if 
they did come into compliance, what the impact of that may very 
well be on this problem.
    The last issue that Ms. Kaptur addressed, did you have a 
projection, either of you, of what the trade deficit with China 
will be? It was $104 billion last year. This year, it is going 
to be about $120 billion. What are your projections, if nothing 
changes, for the year 2005, which is just 2 years from now? Do 
you have any projection for that yet? Well, you really have to 
do that, though.
    Mr. Freeman. I know that the Council of Economic Advisers 
[CEA] does some studies on that.
    Representative Wolf. Well, if you could give the Commission 
a projection. I know it is difficult to go in the out years to 
2010, but if you would take the current circumstances the way 
they are and give us a prediction of what you think it will be 
in the year 2005.
    And the last question is, what impact is this now having, 
not only on manufacturing, but on the high-tech industry? I am 
beginning to see more stories about the high-tech. What is the 
impact that you see China having on the high-tech business 
community? That is my question.
    Mr. Freeman. Well, there are two things. I mean, one, if 
you are looking strictly at semiconductors, for example, 
China's value added tax policy actually encourages domestic 
production of semiconductors in China.
    What that does is encourage migration of our production to 
China. That is something which we don't want to see. Again, we 
have been talking to China extensively about the WTO 
consistency of their VAT rebate policies.
    What we want to do is make sure China understands not only 
that the policy of VAT rebates may be WTO inconsistent, but 
there actually are multiple good reasons to maintain imports 
from the United States of semiconductors for purely economic 
reasons. So, that is where we are on semiconductors.
    I will say that one of the areas that we are profoundly 
concerned about and which China really needs to stop the words 
and start producing deeds, is on intellectual property rights, 
which has impacted not just the high-tech area, but everything 
from auto parts to Zippo lighters. I mean, if we can make it, 
they can fake it, quite frankly.
    And one of the things that we need to see is China taking 
steps to not just produce a WTO-consistent IPR regime, a legal 
regime, but actually make sure that they are creating 
deterrent-level criminal penalties that put IPR infringers 
behind bars.
    Unless that happens, we are going to continue to see a lot 
of IPR violations, IPR problems, for everything from 
semiconductor masking piracy to reverse engineering of our 
high-tech products taking place in China.
    It is something that China's leadership right now seems to 
understand. At least, they are telling us that they understand 
the role of IPR in a mature economy. But, very frankly, once 
you get past that top leadership, it gets real murky.
    That is why the leadership has to step up and say, all 
right, we are going to put criminal penalties in place that are 
going to put some of you guys behind bars. And we do not care 
who you are, you are going behind bars if you infringe IPR. 
That is something that Ambassador Zoellick has been very 
focused on, frankly.
    Representative Wolf. Thank you, Mr. Chairman.
    Chairman Leach. Thank you.
    Are there further questions of this panel?
    [No response.]
    Chairman Leach. If not, we want to thank you all very much, 
and we will turn to the next panel.
    Panel 2 is composed of Gary Martin, who is president and 
CEO of the North American Grain Export Association. Mr. Martin 
proudly served in the Administration of George H.W. Bush at the 
U.S. Department of Agriculture, and in the Clinton 
Administration as advisor to the Special Ambassador to the 
former Soviet Union.
    Mr. Brad Smith is currently managing director for 
international affairs, American Council of Life Insurers. Mr. 
Daryl Hatano is the vice president of public policy with the 
Semiconductor Industry 
Association [SIA].
    Mr. William Primosch is director of the international 
business policy in the International Economic Affairs 
Department of the National Association of Manufacturers [NAM]. 
He is a former career diplomat of the U.S. Department of State. 
Unless there is a prior agreement with the panel, we will just 
go in the order in which you were introduced. Is there any 
disagreement with that?
    [No response.]
    Chairman Leach. All right. Then we will begin with you, Mr. 
Martin.

  STATEMENT OF GARY MARTIN, PRESIDENT AND CEO, NORTH AMERICAN 
            EXPORT GRAIN ASSOCIATION, WASHINGTON, DC

    Mr. Martin. Thank you, Mr. Chairman. I will speak today, as 
have previous speakers with their comments and the discussion 
so far today, about agricultural market access issues. That is 
the entire focus of my association's work, and indeed a passion 
of my personal career.
    Additionally, I ask that you accept my formal comments into 
the record. I understand that time is short, so I will be as 
brief as possible in making my comments. I think that you have 
already seen a demonstration of the importance of the Chinese 
market and the importance of success in that market.
    Chairman Leach. If I could interrupt for a second. Without 
objection, the full statements of all panel members will be 
placed in the record, and you can proceed as you see fit. 
Please, go ahead.
    Mr. Martin. Thank you.
    I think you have seen a demonstration of the importance of 
the Chinese market and China's successful implementation of its 
WTO commitments. The importance to agriculture and the 
agricultural economy here in the United States cannot be 
overstated. It is a dominant market force globally. The Chinese 
agricultural and food system is very important to us.
    We have had some successes. Investment has been directed to 
China. Trade has been directed to China. I would point out 
that, in the last 5 years, we have seen a quadrupling of 
agricultural exports to China, much of that as a result of the 
accession to the WTO.
    However, we still have some difficulties. In my testimony, 
I get into quite a bit of detail about those issues. But I want 
to point out, in particular, six key issues, and then address 
some recommendations for progress along these lines. Several of 
these issues have been mentioned already this morning, so I 
will keep it short.
    The uncertainty regarding biotech regulations is, indeed, a 
continuing issue. The work of the Administration, and 
particularly the interest of President Bush in this regard, has 
resulted in placing us very close to resolution, but we need to 
close the deal in that regard.
    Labeling on meat and poultry products is certainly a major 
issue for us. Labeling that really does not enhance food safety 
is a considerable problem in China. The Chinese adherence to 
the SPS agreement in the WTO, remains very much an open 
question.
    Continuing attempts by the Chinese customs administration 
to manage trade, particularly import trade, via quarantine 
measures is a continuing issue and a priority of ours, as well 
as export subsidies, particularly for corn, and the range of 
problems we have already heard discussed on the tariff rate 
quota system.
    Our association today asks that the United States 
aggressively focus attention and improve Chinese compliance 
with the WTO in three particular areas. We think this is the 
most bang for the buck and provides the most opportunity in the 
shortest time.
    First, the regulatory practices of the Chinese State 
Administration of Quality Supervision, Inspection, and 
Quarantine [AQSIQ]. Second, complete and final elimination of 
agricultural export subsidies. Third, improvements in the 
implementation of the agricultural TRQ system.
    With respect to AQSIQ practices, current practices are 
unworkable. We have three recommendations in that regard. The 
agency should restrict its activities to science-based 
standards that comply with WTO and international convention; 
the agency should approve import permit requests in a timely 
and commercially realistic manner; and the agency should ensure 
that its operations are transparent.
    With regard to agricultural export subsidies, the problem 
of export subsidies for corn persists in particular. Subsidies 
have resulted in lost sales of U.S. products in key markets: in 
South Korea, Malaysia, Indonesia, and even Japan.
    With regard to agricultural export subsidies, we have two 
recommendations. China should formally and fully account for 
the discrepancy between domestic and export corn prices. 
Finally, China should immediately meet its WTO commitment and 
proceed to eliminate officially supported mechanisms that 
permit exports at lower than domestic prices.
    Our final focus has been discussed quite a bit this 
morning: the agricultural tariff rate quota issue. There are 
new regulations and new practice being developed now in China 
that we need to review to ensure that China is honoring its TRQ 
obligations in a way that provides for transparency and 
commercially feasible quotas. That is important and needs to be 
implemented immediately. Again, it was part of their 
requirements in December 2002.
    In summary, much has been accomplished since China's 
accession to the WTO with regard to its commitments related to 
agricultural trade. However, U.S. expectations are for 
additional and more timely progress. The U.S. and Chinese 
Governments have demonstrated an ability to resolve some 
outstanding issues.
    Given the importance of several unresolved concerns to both 
China, the United States, and global markets, a renewed 
commitment and additional effort by the United States, China, 
and the WTO are warranted. Thank you.
    [The prepared statement of Mr. Martin appears in the 
appendix.]
    Chairman Leach. Thank you very much.
    Mr. Smith.

   STATEMENT OF BRAD SMITH, MANAGING DIRECTOR, INTERNATIONAL 
   AFFAIRS, AMERICAN COUNCIL OF LIFE INSURERS, WASHINGTON, DC

    Mr. Smith. Thank you, Mr. Chairman, for the opportunity to 
testify.
    I would first like to start off by saying that one of the 
reasons that the American Council of Life Insurers [ACLI], and 
our industry counterparts, mainly led by our property/casualty 
counterpart, the American Insurance Association, were such 
strong supporters of PNTR for China was because the accession 
package, consisting of a schedule of specific commitments and 
the working party report, were extremely good market access and 
national treatment commitments for our industry.
    Having just returned from Cancun and looking at some of the 
offers on the table from other major emerging markets that are 
already members of the WTO, and the level of commitments that 
we are now trying to get them to implement, expectations are 
very high.
    Having done several bilateral implementation measures in 
insurance liberalization agreements the United States has 
negotiated with Japan and Korea, we did realize, however, going 
into this process that no agreement is self-implementing. In 
the implementation phase, constant monitoring and enforcement 
pressure is the most important aspect in actually realizing the 
commercial benefits of any agreement.
    Starting this process, I would like to commend the U.S. 
Trade Representative [USTR], the Commerce, Treasury, and State 
Departments, and many interested Members of Congress who have 
helped us establish an ongoing dialog with the Chinese 
Insurance Regulatory Commission [CIRC] which is tasked with 
drafting the implementing regulations.
    Since China's entry into the WTO, CIRC has drafted five 
regulations. The first several were very general and did not 
give a great deal of specificity on how China would live up to 
its WTO commitments. The U.S. Government, led by USTR and 
Commerce, has gone back to the Chinese repeatedly on these 
issues with questions that we have generated and that have been 
generated by consultants we have retained in China. Our goal 
has been to try to take away the corners, get positive 
confirmation on how China will implement her commitments, then 
proceed, get licensed, and begin operations.
    We have several member companies that have operated in 
China that consider the process exemplary, and that their 
communications with CIRC are very positive. We have others that 
are somewhat frustrated with the process. I would just say 
that, over the last 2 years since the beginning of 
implementation, we have noticed positive progress in the area 
of transparency.
    The last two regulations that China implemented to address 
our specific questions with regard to capitalization and 
branching requirements which we had considered a major market 
access barrier actually lowered the requirements by two-thirds. 
Once they are finally adopted and enter into force, we feel 
they will largely address our concerns on capitalization 
restrictions in the Chinese market.
    Another notable development in the recent release of draft 
regulations was that they actually were released in draft. The 
CIRC posted them on its Web site and invited public comment. We 
provided comments within the time they allotted. We have 
translated this into Chinese, sent it to USTR, as well as other 
U.S. Government agencies. Our hope is that, by the end of the 
year, we will be able to continue a dialog with the CIRC to 
clarify our concerns and questions.
    This has actually worked in the past. Our capitalization 
issue, we believe, was addressed because of a meeting that USTR 
and the Commerce Department at the U.S. Embassy in Beijing were 
able to schedule as a face-to-face between our industry and our 
regulators in Beijing in December of last year.
    We are hopeful and cautiously optimistic that by----
    Chairman Leach. If I could interrupt just briefly, Mr. 
Smith.
    Mr. Smith. Sure.
    Chairman Leach. Co-Chairman Hagel has come. He is in a 
meeting with Mr. Bremer on the Iraqi issue and he wants to 
indicate a vote, and maybe make a comment, if you would like. 
Go ahead.
    Senator Hagel. Mr. Chairman, thank you very much.
    I am, first, sorry that I have missed the panel and the 
meeting. But, as the Chairman noted, we have had Ambassador 
Bremer before the Foreign Relations Committee the last 2\1/2\ 
hours, and we go right back into another hearing and I have to 
go preside.
    So, I know they are lame excuses, but, nonetheless, that is 
where I have been, and I am sorry to miss this. I will 
obviously catch up along the way and appreciate, as we all do, 
your presence here, your testimony, your insights.
    I think there is little question of the importance of what 
we are trying to do and what this organization has been about 
the last 2 years. It is critical that we continue to get your 
input and your insights into so many of these issues that will 
have immense consequences in the future for America's 
relationship with China and all aspects of the world. So, thank 
you very much for the time that you have taken to come and 
offer your insights and thoughts.
    Mr. Chairman, thank you very much.
    Chairman Leach. Well, thank you. Thank you for your support 
and for taking time to leave your committee. As you know, 
Senator Hagel, it is my personal view that about half of the 
wisdom in the U.S. Senate resides on your shoulders. Thank you 
for coming.
    Senator Hagel. You are far too generous. But he is from 
Iowa, so that is probably some explanation. But, thank you very 
much. And for Congressman Wolf's attention to this Commission 
over the years. Frank, thank you. You have been a very 
significant part of this and your contributions have been 
important. We appreciate it.
    Representative Wolf. Thank you. If I could say, I like 
seeing you on television because you always tell the truth. 
When the show is over, you always know precisely where you 
stand. A lot of times I agree with you, so I wanted to comment. 
I saw you at the summit.
    Senator Hagel. Thank you.
    Chairman Leach. All right. Thank you, sir.
    Please proceed, Mr. Smith.
    Mr. Smith. Thank you. I would conclude just by saying that 
we think this is the beginning of a process. We have had 
extensive bilateral negotiations or a follow-on on 
implementation through USTR and other U.S. Government agencies.
    We have also worked to mobilize a coalition of our 
competition overseas. The European, Japanese, and South Korean 
insurers that have operations in China have similar concerns.
    At the Geneva transitional review mechanism meetings and 
the Committee on Trade and Financial Services, the United 
States has found itself in an admirable position of leading a 
charge of five or six governments that all have similar 
questions on insurance 
matters.
    To the extent that we can continue to coordinate the 
pressure from international counterpart organizations to try to 
make sure that China fully implements its commitments, we think 
that just adds strength to the effort.
    As I say, this is the beginning of the process. We will 
look forward to getting back to this Commission and to 
interested Members of Congress on the outcome. We have some 
regulations that we just commented on in July and August. They 
are fundamental to establishing the criteria under which 
companies can expand in China. We have provided detailed 
comments and we sincerely hope that those comments are taken 
into consideration. We look forward to reporting to you on that 
by the end of the year. Thank you.
    [The prepared statement of Mr. Smith appears in the 
appendix.]
    Chairman Leach. Good. Thank you, Mr. Smith.
    Mr. Hatano.

  STATEMENT OF DARYL HATANO, VICE PRESIDENT OF PUBLIC POLICY, 
        SEMICONDUCTOR INDUSTRY ASSOCIATION, SAN JOSE, CA

    Mr. Hatano. Good afternoon. My name is Daryl Hatano, and I 
am testifying today on behalf of the $70 billion U.S. 
semiconductor industry, which is America's largest 
manufacturing industry.
    This morning I would like to follow-up on two points that 
Deputy Assistant USTR Charles Freeman made in answer to your 
question, Mr. Wolf, with regard to the value added tax rebate 
program on semiconductors in China and on intellectual property 
enforcement.
    But before turning to these issues, I would like to first 
note the progress that has been made since China joined the 
WTO. Over 80 percent of China's chip market is met by imports. 
The U.S. industry was a major beneficiary of China's 
elimination of semiconductor tariffs last year.
    The United States has also made progress in resolving two 
WTO implementation issues, one related to a trade barrier that 
had prevented China's participation in the Information 
Technology Agreement, and the other related to product coverage 
under China's semiconductor intellectual property protection 
laws.
    SIA appreciates the efforts that USTR and the U.S. and 
Chinese Governments have made to resolve those two issues, and 
we are hopeful that the momentum that we have built from that 
can carry over into the value added tax rebate program and the 
intellectual property issues that I would like to turn to next.
    China currently imposes a value added tax [VAT] of 17 
percent on semiconductors, regardless of whether they are 
imports or domestic production. However, China will rebate to 
domestic producers the amount of that VAT that is above 3 
percent of sales. So, basically it is a discriminatory policy 
that favors domestic production over imports.
    This discrimination violates GATT article 3, which 
prohibits countries from imposing taxes on imported products 
that are greater than those imposed on domestic products.
    To comply with the WTO, SIA believes that the best policy 
for both U.S. export interests, as well as China's economic 
development, is for China to lower the VAT on imports; that is, 
to have the same VAT level for both domestic production as well 
as imports at the lower level that they have announced.
    Many in Congress agree with our conclusion. Earlier this 
year, members of both the House and the Senate, including four 
members of this Commission, sent letters to Ambassador Zoellick 
urging him to vigorously insist that China abide by its WTO 
commitments and lower its VAT on all semiconductors.
    This is also not just a U.S. issue. In May, the CEOs of the 
chip industries in the United States, Japan, Korea, Europe, and 
Taiwan came together under the banner of the World 
Semiconductor Council and proclaimed that China's VAT policy 
``has the effect of limiting market access, distorting patterns 
of trade and investment, and negating the benefits China 
promised to provide when it joined the WTO.''
    As a result of this attention, China has formed a research 
group to reexamine the VAT issue. In my recent meetings in 
China, we sensed a willingness in some quarters to explore 
alternatives with the United States. However, in other quarters 
there was continued skepticism that changes were necessary. The 
U.S. Government must continue to insist that China quickly come 
into compliance with its WTO obligations.
    The second key issue I would like to cover today is the 
enforcement of intellectual property. SIA is aware of numerous 
reports of IP violations in China. In one case, an SIA member 
company found that Chinese firms were making identical copies 
of its chips and data sheets and selling it under the Chinese 
companies' names. The chips were essentially photocopies of the 
U.S. design, and even included the same unused circuits that 
the U.S. company had put on the chip to reserve space for 
future product development.
    The Chinese firms that engage in piracy are typically 
thinly capitalized companies that rely on foundries to actually 
manufacture the product. These foundries are the ones that are 
able to afford the multi-billion dollar investments that are 
required in our industry.
    The court system in China is still developing, and U.S. 
firms are concerned about the fairness of their procedures. 
China also has administrative enforcement mechanisms, but these 
are largely untested. The Chinese Government has expressed a 
willingness to work with the United States to improve its IP 
enforcement.
    It is worth noting that IP enforcement is critical, not 
only to U.S. firms doing business in China, but also in China's 
self-interest, as it will encourage foreign high-tech 
investment in China, as well as encouraging local innovation in 
China.
    SIA urges the U.S. Government to devote the necessary 
resources to address the many technical issues in China's IP 
enforcement procedures.
    China is a large and growing market. While the challenge of 
the transition from a planned to a market economy is immense, 
we are encouraged by China's progress and the commitment 
demonstrated by Chinese Government officials in our recent 
meetings. We look forward to continuing to work with the U.S. 
Government to further China's movement toward implementing its 
WTO commitments. Thank you.
    [The prepared statement of Mr. Hatano appears in the 
appendix.]
    Chairman Leach. Well, thank you, Mr. Hatano. I think you 
have not only set a record for staying within the time limit, 
but for someone with so many degrees, including an MBA and a 
law degree, that is particularly impressive. Usually, the 
longer the number of degrees, the more discursive. So, thank 
you.
    Mr. Primosch.

STATEMENT OF WILLIAM PRIMOSCH, DIRECTOR, INTERNATIONAL BUSINESS 
 POLICY, NATIONAL ASSOCIATION OF MANUFACTURERS, WASHINGTON, DC

    Mr. Primosch. Thank you, Mr. Chairman, for giving the 
National Association of Manufacturers [NAM] an opportunity to 
testify on a subject of great interest to our members.
    I can tell you that we hear more from our members about 
trade with China than with any other foreign country. In fact, 
Mr. Chairman, at our meetings of the NAM board yesterday 
afternoon and this morning, China trade concerns dominated our 
discussions.
    Trade with China is of immense importance for U.S. 
manufacturers because China is both a large, rapidly growing 
market for U.S. products, and at the same time a fierce 
competitor in the United States and global marketplaces.
    As China concludes its second year as a WTO member, 
however, its compliance record is decidedly mixed. The NAM has 
received far more complaints about Chinese trade practices this 
year than in the previous year.
    In a recent survey, our members identified a variety of 
policies that have provided Chinese exporters with unfair trade 
advantages and created significant non-tariff barriers that 
hindered market access, and many have been mentioned already by 
my colleagues and by members of the Commission.
    At the top of the list is currency manipulation and China's 
deliberately undervalued currency. In the view of many 
manufacturers, China's undervalued currency is the single most 
important factor driving the growing trade imbalance between 
the United States and China.
    Economists have estimated that China's currency could be 
undervalued by 40 percent or more. As of July, China had 
accumulated more than $350 billion in foreign exchange 
reserves. This is far in excess of what IMF analysis indicates 
is necessary, and a clear indication of currency 
undervaluation.
    Another concern relates to subsidized exports. We continue 
to receive reports from different industries that Chinese 
products are being sold in the United States at prices so low, 
they could not cover the cost of raw materials and shipping, 
much less full production and marketing costs. These reports 
suggest the possibility of widespread use of subsidies, either 
direct, or very likely indirect.
    A third major concern was mentioned by other panelists, and 
that relates to counterfeiting and intellectual property rights 
violations. Violations of trademarks through product 
counterfeiting is rampant on a truly massive scale, and is 
within the knowledge and purview of both local and national 
government authorities.
    While Chinese laws on intellectual property rights 
protection have improved considerably, the lack of effective 
enforcement of IPR protection remains a serious problem.
    Other problems were noted by our panelists, and they have 
also been noted to us at the NAM: value added tax 
discrimination; problems with standards and the application of 
the CCC Quality Mark System; failure to implement automobile 
financing regulations that were promised under the membership 
agreement, and resistance to allowing U.S. companies to have 
export and import rights as required under market access 
pledges.
    In short, Mr. Chairman, we see a variety of unfair 
practices that are impeding U.S. exports to China and providing 
Chinese products with competitive advantages in the U.S. 
market.
    The Commission has asked for policy recommendations for 
changes, things that could be done better. We have a few 
suggestions. But, first, we would like to say that U.S. 
agencies, particularly the Commerce Department, Treasury 
Department, and USTR have been making good efforts to advance 
U.S. trade interests and deal with a lot of these problems.
    The scope of the challenges, however, requires a much 
larger scale effort than currently exists. The NAM recommends 
the following five-point action plan:
    First, compliance with WTO trade rules and market access 
commitments are critical for creating a level playing field. 
Commerce and USTR need additional staff to monitor, and more 
importantly investigate, WTO compliance concerns. Current 
resources are not adequate to do the job right.
    Second, we must continue to press China to end the 
manipulation of its currency and to allow the yuan/dollar 
exchange rate to be determined by market forces. Secretary 
Snow's visit was an excellent start, but we need to keep the 
pressure on China and we need to involve our other trade 
partners, particularly the G-7.
    The NAM is prepared to support a section 301 trade 
complaint in concert with other members of the Sound Dollar 
Coalition as a way of underscoring the seriousness of this 
matter.
    Third, we must effectively address subsidized and non-
market based production. Fourth, we must take firm action to 
end China's rampant counterfeiting and violations of 
intellectual property rights and use trade action when 
necessary.
    Finally, and I would like to thank Congressman Wolf for his 
support and interest in this, we need to support a much larger 
scale public-private sector trade promotion effort to increase 
U.S. exports to China.
    In 2003, China will become the world's third largest 
importer, with $380 billion in imports. We will only get 8 
percent of that import market. We can do better than that. 
Thank you, Mr. Chairman, for giving me the opportunity to 
testify.
    [The prepared statement of Mr. Primosch appears in the 
appendix.]
    Chairman Leach. Thank you, Mr. Primosch.
    I want to just ask one question, and it is of you, Mr. 
Primosch. It relates to your very last phrase and the 8 percent 
issue of U.S. participation in exports to China.
    Does the NAM, or does anyone in our government, keep 
statistics on the relationship of the U.S. trade deficit in 
contrast, most particularly with the European Union, but with 
other parts of the world? For example, we have about a $400 
billion deficit this last year in trade. What is the EU's? What 
is the relationship of their exports and imports?
    It strikes me, there are two very interesting general 
statistics. One, is the statistic of what China imports from us 
relative to what we import from them. Second, what China 
imports from us relative to comparable groupings of societies. 
For example, the EU, in relationship to what the EU imports 
from them.
    Do you have those figures?
    Mr. Primosch. I have some of the statistics, Mr. Chairman.
    Chairman Leach. Go ahead.
    Mr. Primosch. I think you have raised a very interesting 
point. The European Union exports about 50 percent more to 
China than the United States. The European Union imports 
considerably less from China than the United States. I do not 
have that exact figure.
    But what is interesting is that, I think, particularly in 
manufactured goods and in machinery, for example, the European 
Union exports about $7 billion more than we do. It is not quite 
clear why they are able to do that.
    Someone earlier in our discussion mentioned standards.
    Chairman Leach. Mr. Bereuter. Yes.
    Mr. Primosch. Is this because European governments support 
their businesses more? That is an issue. I think there is more 
support by their governments of export promotion. That is an 
issue. They are much more supportive of their companies in 
China. And I think we also have to admit that many European 
companies, and particularly smaller companies, are more export 
oriented. They perhaps put a little more effort into it. That 
is something that U.S. manufacturers can learn from that as 
well. So, I think it is a variety of factors.
    Chairman Leach. Yes. To the degree that there is a managed 
trade element--and there is--now, there is a free aspect of 
trade with China that goes on, and we understand that. There is 
a managed element that goes on and we somewhat understand that. 
Should we be expecting China to be importing comparably at 
least as much from us as they do the EU? Is that a reasonable 
expectation of the United States?
    Mr. Primosch. I think that is a reasonable expectation. 
Particularly now with the decline of the dollar against the 
euro, we would expect to see more exports to China from the 
United States in a lot of these manufactured goods areas than 
from the European Union. So, yes, I think you are correct on 
that, sir.
    Chairman Leach. Thank you very much.
    Sandy.
    Representative Levin. Thank you. Thank you for your 
excellent testimony.
    Let me just say a word about the WTO compliance and the use 
of the annual review. Each of you come from somewhat different 
sectors. Do you feel there is enough interaction between 
yourselves and our government as it prepares for these annual 
reviews? The second one is now under way, or will soon be under 
way.
    It is one forum, an important forum, for us to raise these 
issues, to press these issues, to secure support from other 
countries so it is not simply the United States and China.
    So, what are your thoughts about that? Is there enough back 
and forth? Are you enough of a participant? You think you are?
    Mr. Martin. With respect to the WTO annual review?
    Representative Levin. Yes. Exactly.
    Mr. Martin. Yes. I think that the interaction between the 
agricultural community, USTR, and USDA, in particular, is 
sufficient. They have identified the issues clearly and have 
taken them forward to the WTO process. I do not see any gaps in 
understanding what the issues are and where we're at.
    Representative Levin. But how about the intensity of our 
pressing them?
    Mr. Martin. I think that is a matter of resource 
allocation. I agree with the previous comments, there are not 
enough resources there today to deal with the size of the 
market that China represents.
    Representative Levin. All right.
    Mr. Primosch. If I could make an additional comment. I do 
think we have very good cooperation with both the Commerce 
Department and USTR. They do welcome our input, and they make 
themselves available.
    In fact, there will be a hearing on October 3--probably 
many of us will be testifying there. We have provided a 
detailed report on China's compliance to USTR, and we will have 
an opportunity to make additional comments at the hearing.
    However, I do think that many of the issues that we have 
identified are resource-intensive issues. When you get into 
issues like standards or intellectual property rights, for 
example, of automobile parts that are being counterfeited, you 
need to do investigative work and really pin down where this is 
happening and follow through. Clearly, there are not enough 
resources for that kind of intensive investigation and follow-
up, in our view.
    Representative Levin. That is important. Mr. Wolf, my guess 
is, has taken note. We should not short-change this annual 
review. We work to have it occur and we have got to make it 
meaningful. I think China needs to realize that it is an 
important forum, and it can be a constructive effort. So, that 
is point one.
    Second, I just want to mention, in terms of the currency 
issue, I just want to refer again to article 15, paragraph 4, 
because there are some who question whether there is any 
relationship to the WTO.
    That article 15, paragraph 4 prohibits WTO members from 
using ``exchange action'' to ``frustrate the intent of the 
provisions of the WTO.'' So, it seems to me there is a clear 
basis for our utilizing measures within the trade ambit 
relating to currency valuation.
    The last point regarding counterfeiting of intellectual 
property. I think when people hear that, they think mostly 
about movies. That is the most common one. Because when you go 
to Beijing, as I have, you walk down the street and pretty soon 
somebody says, ``Would you like to buy a CD, now a DVD? ''
    But is it not a larger problem than that? Does it not 
relate to manufacturing and the products that are made? Do any 
of you want to comment on that?
    Mr. Hatano. Well, it is also a semiconductor problem. We 
have the sort of problems where they are copying semiconductor 
chips. We can use the term ``counterfeiting,'' but from a legal 
perspective it can be a violation of the semiconductor mask 
work law, similar to what we have here in the United States, 
because it is illegal to just copy the designs of a chip. It is 
also a violation of copyright law because they are often 
copying our data sheets and other things that go with that, and 
any software that is accompanying the chip. It is also a 
violation of trademarks, because they are selling it under our 
name.
    There is also a consumer fraud element because effectively 
what they are doing is trying to get the customers to think 
that it is a U.S. product with U.S. reliability behind it. So, 
there are a lot of aspects to it and it is something that is 
one of our highest priorities.
    Representative Levin. Yes, Mr. Primosch.
    Mr. Primosch. May I just add to that? Congressman, you are 
absolutely right. This is not just a problem with films or CDs. 
Virtually every manufactured product or consumer good has been 
counterfeited in China, from footwear and health care products 
to pharmaceuticals.
    I have even heard from a representative of the auto 
industry of an entire automobile that was counterfeited. This 
is a very serious problem for a wide range of manufactured 
products and it has many dimensions.
    For example, with pharmaceutical products, the 
counterfeiting of medicines has implications for public health. 
In fact, counterfeit medicines have been identified as one of 
the most serious public health problems in China. So, yes, it 
is much broader than just films or CDs. It affects a wide range 
of manufactured products, particularly in the auto industry.
    Representative Levin. Thank you, Mr. Chairman.
    Chairman Leach. Thank you.
    Mr. Wolf.
    Representative Wolf. Thank you, Mr. Chairman. I have a 
meeting at 12:30, but I just wanted to make a couple of 
comments for the record, and ask you a question.
    The EU does better. Germany actually has a trade surplus, 
not a trade deficit. Frankly, I think part of the 
responsibility of the business community has been very 
complacent. You all have been so complacent. I think some of 
you--and I am not addressing you four, I am talking in 
general--have been very reluctant to speak out. It is like you 
are afraid. You are afraid the Chinese will prevent you from 
doing business.
    I think you have actually been part of the problem, in the 
sense that you have not been assertive--now, I sense that is 
changing. I appreciate the NAM taking the leadership that it 
has been taking lately. But I think that you have been very 
reluctant to be bold, to speak out. You have been very 
reluctant.
    For some of you--again, I am not speaking to the four of 
you--in the industry, it will be too late. For garlic, it will 
be too late. The garlic industry will, for all practical 
purposes, go. California will no longer be the big garlic 
producer.
    Apples. The apple industry is precarious. As this moves, 
applesauce now coming in, now apples. As you cut down those 
apple trees, the subdivisions go up. So, for apples, it could 
be at the end point.
    So, I think the fact that you are beginning to speak out is 
very healthy. And I do not want to get into how this is a 
country that is a godless, Communist country. I think you have 
to realize that. I mean, Ronald Reagan's finest speech was when 
he called the Soviet Union ``the Evil Empire,'' because he 
called it what it was.
    I think now the Administration is beginning to kind of 
catch the vision. They are concerned politically. I think they 
now have had these series of meetings and know how serious a 
problem it is.
    I think you all should push. Why would we not bring a VAT 
case with regard to the violation that you mentioned, Mr. 
Hatano? Why would you not insist? This is your government. 
These are people who are working for you. So, you should 
insist. The industry in my area, the Manassas facility which 
you may or may not be aware of, has lost a lot of jobs that 
have gone out. So, you should insist. This is your government. 
This is not something that you should be fearful of. They 
should bring the case.
    Just very quickly, I want to ask you this. I read this 
article in today's National Journal. It says, ``Officials from 
the National Association of Manufacturers and the AFL-CIO''--
that's an interesting combination, when you get those two 
together--``now expect to ask the White House to begin a so-
called section 301 investigation into whether China is 
maintaining an unfair trade advantage by keeping its currency 
artificially strong.''
    Just yes or no. I know where you are now, but do you think 
that there should be a case brought? One.
    Mr. Martin. On the currency issue?
    Representative Wolf. Yes.
    Mr. Martin. I think that the Chinese approach to currency 
valuation is inappropriate and needs to be changed. Whether or 
not the 301 case is----
    Representative Wolf. By bringing the case, that would not 
be a protectionist act, would it? It would seem, based on what 
Senator Levin said, it would not be. The law requires, as you 
get into a case, that we have a law and we can work within that 
law. So would you think that would be a violation or a 
protectionist act for us to bring a case with the NAM?
    Mr. Martin. Section 301?
    Representative Wolf. Yes.
    Mr. Martin. I am not an expert in trade law.
    Representative Wolf. No. But, I mean, from your own----
    Mr. Martin. I think that it sounds logical. I think that 
our standard for all of the actions that we contemplate against 
China is what will be the most expeditious.
    Representative Wolf. And if this were solved, this would 
help you tremendously.
    Mr. Martin. If it does it in a timely fashion and something 
else would not be a better alternative.
    Representative Wolf. Mr. Smith, do you think this should be 
a case? Be bold, now. Just tell us honestly. If you do not 
think so, say so.
    Mr. Smith. We do not actually produce stuff in the United 
States.
    Representative Wolf. No, but you insure people who do, 
though.
    Mr. Smith. Our companies actually set up operations in 
China and then repatriate the profits.
    Representative Wolf. So you are neutral then. All right.
    Mr. Smith. Yes.
    Representative Wolf. Mr. Hatano.
    Mr. Hatano. We have not taken a position on the currency 
issue. We want to make sure that whatever currency exchange 
rates there are are the right ones, and we support and applaud 
the efforts of the Administration, and NAM, and others who are 
taking the lead on that. But we have not taken a position on 
what the right mechanism ought to be to get there, or what the 
right level is.
    Representative Wolf. But the Chinese have no reason to give 
unless they are forced to give. I mean, that is business.
    Mr. Hatano. Yes, I certainly understand that.
    Representative Wolf. They are very tough people. I mean, 
the long march that Mao took. This is not a day care facility 
manager. These are very tough people.
    I do not want to abuse my time. I think you should take a 
position. If it is no, it is no. If it is yes, then yes.
    Mr. Hatano. If I can touch on your question on the VAT.
    Representative Wolf. If the Chairman will allow.
    Chairman Leach. Go ahead.
    Mr. Hatano. The semiconductor industry has been very 
aggressive with trade actions in the past. In the Japan case, I 
think it is fair to say that we were the first ones to really 
use 301, when we were at that time being advised not to really 
file a case because it was something one threatens to use 
rather than uses.
    Representative Wolf. Advised by whom?
    Mr. Hatano. The U.S. Government. This is back in the 1980s, 
with Japan. I am just saying that we have been very aggressive 
when we have needed to be. With regard to the VAT, I think we 
have tried to take a very reasonable approach and talk with the 
Chinese, make sure they are fully aware of what the problem is, 
and make sure that they are actually trying to deal with it.
    But we will cross the bridge when we get there in terms of 
filing a case. I am just emphasizing that we have not been shy 
in the past.
    Representative Wolf. Well, some of those jobs will no 
longer be here, though, if you take too long to cross the 
bridge.
    Mr. Hatano. I understand.
    Representative Wolf. I think you have to deal with that.
    And I want to commend the NAM. I think you all have really 
been providing the leadership. I think, this is your 
government. I mean, Ambassador Zoellick is a good man. I think 
he is a constituent, lives in my district. Good man. He works 
for you. You pay his salary. We all work for you. We are public 
servants. We are supposed to give you the best judgment.
    But I think it is appropriate for you to push your 
government to be responsive. I think, for a long period of 
time, it has not been. Now I believe that it is. And now that 
it is, I think this is not the time to let up. This is the time 
for you to be aggressive and to push, because I think this is 
something that can be done.
    I think, quite frankly, there is probably a representative 
of the Chinese Government here writing down everything. This 
government will fall. This government will fall. And when it 
falls, it will be chaotic, so there will be an opportunity for 
the people of China to live in freedom, for Catholic bishops to 
give Holy Communion, for Tibet to be free. It will fall. It 
will fall and it will crumble and they will pull the people out 
of the palaces and wherever they are in Beijing and they will 
be held accountable. So I think the more you are pushing, the 
sooner we can bring freedom, democracy, and opportunity and 
openness.
    But the way to do that is the way that Ronald Reagan did 
it, by being bold, by standing for our values, by articulating, 
and not being mean, not being aggressive, not being rough, not 
being rude, but bold. So, I think it is time for the industry--
and I think you are now beginning to do that--to be bold. When 
you are bold, this government will collapse. There will be 
freedom. There will be opportunities. But it will not come as 
fast if you do not push.
    I appreciate you being here, and I thank the Chairman for 
the extra time, and yield back. Thanks.
    Chairman Leach. Well, thank you very much. I thank this 
panel. I would indicate, Frank, that there are expected votes 
on the House floor in the near future.
    Representative Wolf. I am going to a meeting on the House 
side.
    Chairman Leach. All right.
    Do you have any further questions, Sandy?
    Representative Levin. No, thank you.
    Chairman Leach. Then we will move to the next panel, which 
is the distinguished panel of academics. It is composed of 
Lawrence J. Lau, who is the Kwoh-Ting Li professor of economic 
development at Stanford University; Margaret M. Pearson, who is 
professor of government and politics at the University of 
Maryland; and Yasheng Huang, who is associate professor at the 
Sloan School of Management at the Massachusetts Institute of 
Technology.
    We welcome the panel. Again, unless there is a prior 
arrangement, we will proceed in the order in which the 
introductions were made.
    Professor Lau.

    STATEMENT OF LAWRENCE J. LAU, KWOH-TING LI PROFESSOR OF 
    ECONOMIC DEVELOPMENT, STANFORD UNIVERSITY, STANFORD, CA

    Mr. Lau. Thank you, Mr. Chairman, distinguished 
commissioners, ladies and gentlemen. It is a great honor for me 
to have the opportunity to testify before your commission. I 
have some written testimony. May I request that it be submitted 
for the record?
    Chairman Leach. Let me be very precise. All statements will 
be fully presented in the record, if there is no objection. You 
may proceed as you see fit. If it is at all possible, we would 
like summaries.
    I know that is very difficult from the academic arena. We 
do have an awkward situation of intervening votes. So, please 
proceed, Professor.
    Mr. Lau. Thank you very much. I will try to be very brief.
    First of all, I would like to say I really endorse the 
discussion about the intellectual property rights issue. I 
believe that if it actually can be pushed successfully, that it 
would really greatly increase the exports that we might be able 
to send to China.
    But I want to mostly focus on the currency situation and on 
the trade balance. I think one of the things that I would like 
to point out is the following: Although China has a very large 
surplus with our country it actually has a deficit with the 
rest of the world. So, the aggregate total of the Chinese 
surplus with respect to the world is actually not very large. 
The estimate this year, 2003 is expected to be around $10 
billion worldwide.
    Now, when one contrasts this with the Japanese experience, 
Japan has a large surplus with us, about $80 billion in 2002, 
or $60 billion, depending on whose numbers you use. But Japan 
actually has a very large surplus with the whole world. It is 
about $80 billion.
    So, if there is any disagreement, it is really very much on 
the Japanese side, because the Chinese side on current 
accounts, is actually pretty close to balance. Now, of course, 
this does not detract from the fact that we have a large 
deficit with China.
    The second point I would like to make is that if you really 
look at the Chinese exports to us, the value added component is 
actually very low. It is about 20 percent. That means, for 
every dollar that they ship to us, the contribution in China is 
only around 20 cents.
    Now, why is that the case? That is the case because Chinese 
exports consist mostly of what we call processing and assembly 
activities, which means that they take what other people have 
built, they make goods out of other people's components and 
then they ship the goods to us. So what they are doing is 
really final finishing and assembly.
    There are two implications. One is that the value added, 
the gain that they get from these large exports to us, is 
actually not that large because a lot of it actually goes back 
to Japan, South Korea, Taiwan, and ASEAN countries.
    With all of them, China actually is running a huge deficit 
because they are taking their parts and components and they are 
just putting them together, but they all come here to be sold 
and the total counts as Chinese exports. So, I think we need to 
take that into account.
    But the true implication of that is the following: The 
currency movement would not be very useful. I actually support 
very much Congresswoman Kaptur's opinion that the problem is 
not the exchange rate.
    But here, the way to think about it is if the import 
content is 80 percent, if you appreciate the value of the 
currency, what it does is it makes the imported material 
cheaper, although it makes your part more expensive.
    So, I have done the calculations and, basically, a 10 
percent revaluation would only increase Chinese export prices 
here by 2 percent. It would take a draconian increase in the 
exchange rate to make any dent at all.
    Now, to convince ourselves that the exchange rate does not 
really matter, all we have to do is to look at the Japanese 
example. From 1960 to now, we have actually managed to push the 
yuan up from 360 yuan per dollar to, I think yesterday it was 
about 112, a huge appreciation. Has it made any difference? No. 
I mean, basically the trade deficit continues and it is just 
about as large as before.
    I think, fundamentally, what we need to do is to change the 
mind-set, change the Chinese mind-set, that they ought to start 
importing from us. We should look at the results. The results 
ought to be that these countries should have overall balance 
with the whole world and, therefore, would not take unfair 
advantage.
    Now, if in fact Japan could have balance with the whole 
world, that means they would have to import $80 billion more 
and the United States would actually be a beneficiary if, in 
fact, imports could be stepped up.
    So let me take 1 minute to make one final point. I really 
endorse the Chairman's position, as well as others, that the 
exchange rate ought to be market determined. But in the Chinese 
case, we need to do it very carefully because we know that 
there still exist capital controls. That means that there are a 
lot of buyers for dollars in China who are not allowed to buy. 
Chinese citizens cannot freely buy U.S. dollars.
    Now, if, in fact, we open it up, I think the currency rate 
might well come down rather than go up, if capital controls 
were removed. It is not just on my authority, but Dr. Nick 
Lardy, who is a very distinguished economist working here at 
the Institute for International Economics, as well as Dr. 
Stephen Roach, who is also well-known, both told me that they 
would expect the Chinese currency to go down if capital 
controls were removed.
    Now, if capital controls were not removed, we really do not 
have a free market because lots of people are being excluded. 
So, I think that is really something that we need to think 
through.
    I think we are right to push the Chinese Government to a 
more market-based mechanism, but I think we ought to take a 
look at the sequencing, how that can be done in a way that is 
actually beneficial to us, as well as beneficial to the 
Chinese.
    Thank you very much, Mr. Chairman.
    [The prepared statement of Mr. Lau appears in the 
appendix.]
    Chairman Leach. Well, I want to thank you for one of the 
most interesting 4 minutes of macroeconomics I have heard this 
year. That is extraordinary.
    Ms. Pearson.

 STATEMENT OF MARGARET M. PEARSON, PROFESSOR OF GOVERNMENT AND 
       POLITICS, UNIVERSITY OF MARYLAND, COLLEGE PARK, MD

    Ms. Pearson. Thank you for inviting me to speak in this 
discussion. I have submitted written testimony that talks about 
two topics. One is the evolution in year two of China's WTO 
implementation toward rule of law commitments. I am not going 
to speak about that in my oral testimony.
    But I will speak about the second topic that I am writing 
about, and that is a somewhat different perspective than we 
have heard in this forum previously, but it does relate to rule 
of law issues.
    This is to ask the question, ``Is China, now that it is a 
member of an international organization, and responsible for 
ongoing and future regulation of trade and foreign investment, 
playing by the rules of that international body in Geneva at 
the international level? '' Now that we are nearly 2 years into 
the process, it is useful to evaluate China's behavior in this 
regard.
    Prior to engaging in any assessment of this, though, I 
think it is very important to highlight a distinction about the 
use of the terms ``cooperation'' and ``playing by the rules.'' 
It is very important that we not conflate the notion of 
cooperative behavior with adherence to the U.S. Government 
agenda in WTO.
    While, of course, we may strongly prefer that China's 
agenda in the Doha Round is aligned with the preferences of the 
U.S. Government, playing by the rules in this body really must 
be measured in terms of whether a country abides by the norms 
and rules of the organization as a whole.
    Cooperation cannot be defined by the absence of conflict 
with other nations, since conflicts over trade interests are 
assumed and built into the process. Indeed, as Mr. Freeman said 
this morning, the whole reason, or a big part of the reason, 
why we wanted China to join the WTO, is so we had a place to 
take disputes, just as we have a place to take disputes with 
some of our best trading partners and political allies.
    My bottom line answer as to whether China is playing by the 
rules in this forum at the international level, is that it has, 
by and large, played by the norms and rules of the 
organization. The Chinese have made no strong effort to change 
the conservative consensus rules, and it accepts the informal 
norms of consultation in the organization. I do expand on this 
in my written testimony, and will refer you there.
    Chairman Leach. If I could interrupt for a moment.
    Sandy, there are two votes pending. They are both important 
votes in the House. They are of a substantial nature relating 
to homeland security. What I suggest, Sandy, is that we recess 
and return.
    Representative Levin. All right.
    Chairman Leach. So that the panel in the room understands, 
it will probably be a full 15 to 20 minutes. I apologize to 
each of you for that, but we are obligated to vote where we 
can.
    Representative Levin. We made it by 6 seconds last time.
    Chairman Leach. Right. Thank you.
    [Whereupon, at 11:56 a.m. the hearing was recessed.]

    [The hearing was reconvened at 1:21 p.m., Chairman Jim 
Leach presiding.]
    Chairman Leach. Well, I apologize for the recess, but the 
Commission will reconvene.
    Ms. Pearson, you were in the middle of your testimony. 
Please proceed.
    Ms. Pearson. Thank you.
    I had just finished saying that my bottom line answer to 
this question of whether China plays by the rules in the WTO at 
the international level, meaning in Geneva and in other 
international forums, is basically that it has.
    Mr. Freeman, this morning raised the issue of the TRM, the 
transitional review mechanism. Indeed, it was very prickly last 
year. That is an area where China has skated close to breaching 
some of the norms of what is expected, although I agree with 
Mr. Freeman that things look much better for this year.
    The second area where China's behavior is more 
questionable, is on the issue of Taiwan. This is not a 
surprise, certainly, to anybody who studies China's role in 
international organizations. I think there is not much that is 
going to change there, but this is considered par for the 
course and is generally tolerated.
    I wanted to speak just for a moment about China's role in 
the Group of 22 at Cancun in the Doha Round negotiations 2 
weeks ago, though, because it has received quite a lot of 
attention.
    I believe that, if we were to listen to the headlines which 
tell us that China is leading, along with India and Brazil, the 
Group of 22 to tear apart the negotiations at the WTO, this 
would be somewhat misleading, and I want to provide some 
analysis of that.
    I confess that China's participation in this Group of 22 
took me somewhat by surprise in light of China's earlier 
expressions of its interest in agriculture, and when, 
particularly on tariffs, they expressed quite a lot of 
commonality with the proposal put forward by Ambassador 
Zoellick and Secretary Veneman last year.
    However, when you dig deeper into the issue, several points 
become clear. Let me, just for the sake of time, list them 
briefly.
    China did, of course, lend quite a bit of weight to the G-
22 initiative and gave voice once again to its commitment to 
building a bridge with the developing world. But if you look 
carefully, China was not an active leader of this action. 
Brazil and India were much more important, particularly Brazil.
    Commerce Minister Lu Fuyuan's comments in Cancun were 
designed to be quite conciliatory, in great contrast to the 
confrontational statements by the other ministers there. 
Indeed, it was quite clear that China did not wish to see the 
talks break down or to alienate any other party.
    Moreover, statements in the Chinese press about the 
meetings and about China's participation in this coalition of 
developing countries have been mostly absent. Stories on the 
meeting have been very descriptive and simply expressed hope in 
moving talks ahead.
    There is no attempt to gain domestic leverage, to say that, 
China is standing up tough to the United States and to the WTO 
and to the developed countries. That is absolutely absent in 
the Chinese coverage of it.
    So, I will just leave you with the thought that, as has 
been my impression earlier about China's basic willingness to 
play by the rules of that international organization, the 
events in Cancun really do not breach that basic conclusion. 
Thank you.
    [The prepared statement of Ms. Pearson appears in the 
appendix.]
    Chairman Leach. Thank you very much, Ms. Pearson.
    Mr. Huang.

 STATEMENT OF YASHENG HUANG, ASSOCIATE PROFESSOR, SLOAN SCHOOL 
     OF MANAGEMENT, MASSACHUSETTS INSTITUTE OF TECHNOLOGY, 
                         CAMBRIDGE, MA

    Mr. Huang. Thank you, Mr. Chairman, for giving me this 
opportunity to testify about a very important issue in Sino-
U.S. 
relations, as well as an important issue in China's political 
and economic transition to a market-based economy.
    I sat through the previous two panels. It is an extremely 
educational experience for me. To some extent, it reminds me of 
the many conversations I had with Chinese managers and Chinese 
officials, and they were equally, if not more, mortified by the 
prospect of competing with companies from the United States, 
companies from Europe, companies from Japan after China agreed 
to the WTO terms.
    They were extremely worried about the fact that the state 
sector is doing horribly. They are laying off workers on the 
magnitude of 30 to 40 million since 1996. They attribute a lot 
of that to the fact that the Chinese market is saturated with 
foreign-brand products. They looked at the products that they 
produced in the 1980s, and many of these products disappeared. 
In their place were a lot of 
foreign products.
    So, it is very interesting to hear their sentiment about 
this issue and compare that with the sentiment being expressed 
here. I think the truth is probably somewhere in between, and 
there must be a constructive solution to these very difficult 
problems.
    Let me just raise three points to summarize my written 
statement. The first point, is that China acceded to the WTO 
agreement in 2000-2001, at a time when its economy was actually 
very open to trade and to foreign investment.
    By any conventional measures, China's economy is actually 
quite open. The trade/gross domestic product [GDP] ratio is 
about 40 percent, in comparison with 20 percent for the United 
States and 20 percent for Japan. Foreign direct investment 
[FDI], as a percentage share of domestic investments in the 
1990s was 16 to 17 percent.
    Now it is coming down quite a bit in the last two years. 
That compares with about 6 percent for the United States. So, 
this is a country that has no formal investment barriers, and 
yet the FDI plays a much smaller role in this economy as 
compared with what we normally would call a Communist-
controlled economy.
    If you look at other measures, you see this sweeping 
presence of foreign firms in the Chinese economy. More than 50 
percent of Chinese exports are actually produced by companies 
that are either affiliates or 100 percent subsidiaries of 
foreign firms, and some of them are American firms.
    Of these foreign affiliates, foreign ownership share of the 
equity of these firms is extremely high. Foreign dominance in 
the Chinese industries cuts across the board in many industries 
rather than just in a few sectors of the economy.
    So, here we are talking about an economy that, by these 
measures, actually is quite open to foreign trade and to 
foreign investment.
    The second point that I want to make is that this kind of 
openness is actually quite unusual, for two reasons. One is 
that compared to domestic trade in China, foreign trade is 
increasing. 
Domestic trade, as a percentage of GDP, is actually decreasing.
    Second, there are a lot of barriers. There are barriers 
toward foreign firms investing in China, but there are also a 
lot of barriers established basically to reduce the investment 
potential of the Chinese companies. These Chinese companies 
specifically are domestic private firms. In fact, I would argue 
that an average domestic private company in China has a tougher 
time navigating the Chinese bureaucracy and navigating the 
Chinese legal system than a typical American company in China.
    The third point I want to make is this high FDI inflow into 
China, and a high trade/GDP ratio, are in part driven by the 
inefficiencies of the Chinese financial and legal systems.
    They are not a sign of an open policy toward foreign firms, 
trading with and investing in China. They are a product of the 
fact that the Chinese Government treats domestic private firms 
in a worse manner than it does the foreign firms.
    But in the last 3 years as China began to implement some of 
the WTO provisions, and at the same time the Chinese Government 
began to step up the implementation of internal reforms, the 
role of foreign direct investment was decreasing in China.
    In the mid-1990s, it was about 6 percent of GDP. Today, it 
is about 4 percent of GDP. So I would argue that, as China 
begins to reform its economy at a structural level, in fact, 
you will see more Chinese competition from China than you do 
now.
    Finally, I would just echo the argument made by Professor 
Lau. I do not think it is a currency issue. It is far more 
complicated and more difficult. There are far more complicated 
and more difficult reasons than the simple issue of currency. 
Thank you.
    [The prepared statement of Mr. Huang appears in the 
appendix.]
    Chairman Leach. Well, thank you very much, Mr. Huang.
    Mr. Levin.
    Representative Levin. Thank you for your patience. We are 
really sorry that you had to wait, and also very sorry that 
everybody was not here to hear your testimony.
    I hope that there will be much more exchange between the 
three of you and all of us, because each of you brings a 
perspective that we need to hear and we need to have some 
discussion about them.
    Professor Lau, I think that your view of this needs to be 
very much in the mix of our discussion and we need to find ways 
to have some exchange between you and other economists who 
disagree with you, because this is not a simple issue.
    For example, as you minimize the currency impact of the 
currency picture on page 4, you talk about the yen depreciating 
from 360 in the early 1960s to its current 115. If you would, 
or maybe we can obtain this otherwise, I wonder what it was in 
1995.
    Mr. Lau. It was probably around 240, would be my guess. I 
think somewhere between 240 and 250, would be my guess.
    Representative Levin. But also I think you would have to 
look at, in terms of the impact of currency valuations, the 
impact in specific sectors. The fact that it has a deficit with 
other countries does not exactly answer the impact on the 
United States.
    There is not time, I think, to talk about this now. But 
what I would like to do is to send to you a series of 
questions, all right? Because we need to hear this. What you 
said is somewhat counter to what may be the new conventional 
wisdom on the Hill.
    Then we were also glad to hear the testimony from Professor 
Pearson. Let me just say a word about the TRM. We are kind of 
by ourselves here. But I wanted to comment on your comment 
about how it is received in China.
    I think what you have said, Mr. Leach, means that we have 
to try to communicate to the Chinese Government, why the annual 
review? Some of us on this panel are in part responsible for it 
because it was placed in our legislation. It is unique to 
China, but that was because of the unique circumstances of 
China's accession, both in terms, as you point out, of the lack 
of compliance in advance, but I think even more importantly was 
the size of the Chinese economy, its complexity, and its likely 
impact in the world.
    To have simply followed the norms, review every 4 years, 
was, we thought, going to be counterproductive and in fact 
might escalate the tensions instead of reducing them. We 
thought when we put our proposals together that organizing and 
systematizing a review would perhaps lead to some 
consternation, but in the end lead to less conflict so we would 
not resolve these issues by simply filing cases with the WTO.
    So if this is enormously unpopular in China and it is a 
focal point for concerns about national humiliation, then we 
have to do a better job talking directly to people about why it 
is there. The last thing we are trying to do is humiliate. I 
think it is critical that that annual review work.
    Ms. Pearson. I would agree that it is absolutely critical 
for it to be constructive. There is no point to it if it is not 
constructive. I am hopeful, given what Mr. Freeman said this 
morning, that from both sides it can become more constructive 
than simply an exercise in frustration. So, I appreciate your 
comments very much.
    Representative Levin. All right. Well, my time is up. I 
hope the three of you will be in considerable contact with us.
    Thank you, Mr. Chairman.
    Chairman Leach. Thank you, Mr. Levin.
    I would like to turn a little bit to Professor Lau's 
observations and ask for a filling out of some circumstances.
    When you note that China, as constituted, is doing a fair 
amount of assembling/process kind of work, are you talking 
about a circumstance that is more in the past and less in the 
future, or a circumstance that seems to be the established 
norm?
    By that, I mean it would appear to me that China is 
developing on a rather rapid basis an infrastructure across the 
board in many fields of economic activity. This implies a 
greater prospect of internal Chinese development of a 
manufacturing base that is not as dependent upon imports as 
might have been the case in the past. Now, is that a fair 
observation, or how would you define your predictions of China 
for the future?
    Mr. Lau. Mr. Chairman, I think your observation is correct, 
but I think it is going to be a long process. The Chinese per 
capita GDP today is a little bit less than $1,000 per year, 
which is a very low level. Even though growing very fast, it is 
still a country of great shortages. For example, each worker 
has very little capital to work with. The capital/labor ratio 
is very low and the vast number of people are basically 
unskilled.
    So I see that this assembly and processing work would be 
ongoing for a long time. That does not mean that China would 
not try to move up the chain, but by and large moving up the 
chain does not really provide enough employment. So, I think 
the assembly and processing work would actually be ongoing for 
quite a while.
    If you look at what happened to Taiwan, China is now doing 
everything that Taiwan was doing 25 years ago, assembling 
things. Then Taiwan has moved up. Someone just told me, on 
personal computers and hand-held devices today, that the design 
work is 
actually being done in Taiwan. It used to be done in Silicon 
Valley in California, and now it has all moved to Taiwan. So, 
Taiwan has sort of moved up the chain and just given the 
assembly work across the strait.
    I think that is pretty much what really is happening. Korea 
is doing the same thing. Japan. So the Chinese are getting all 
the 
assembly work, but it does not pay very much. The value added 
proportion is very low.
    Chairman Leach. Let me ask all of you, in a general 
macroeconomic sense, observers of the world economy that 
includes Asia, that is not exclusive to Asia, have noted that 
capacity to produce almost everything is in excess today.
    If you take the human component, if you take the Asia side 
of the Pacific Rim, there are approximately 3 billion people, 
of which two-thirds are work age. If you take America, we have 
110, 120 million in the workforce.
    There are very few things that increasingly, with modern 
communications, apply not only to all of the electronics, but 
with more sophisticated shipping of cargo, and for that matter 
more sophisticated rail shipping in the United States, that it 
is going to be harder and harder to keep manufacturing here in 
America given these trends.
    So one of the great questions is how you bring equity to 
trade. Then it is compounded by this notion that modern 
communications imply productivity improvements that are rather 
substantial. So, last year, the stunning statistic in America 
that we had a 5 percent productivity increase and a decrease in 
employment, that is a fairly stunning thought.
    In a way, it applies to us, but it also could apply to 
China. That is, a 10 percent GDP pick-up may not mean a 10 
percent employment pick-up. When one thinks of massive 
unemployment in China or underemployment in China, that is a 
worrisome thing for their society from their perspective, and 
also one that, from our perspective, makes us wonder how we 
keep our workforce intact.
    Do any of you have recommendations on the right level of 
American judgment that should be applied to our situation and 
the right level of judgment that ought to be applied to theirs? 
How do we parse these demographic situations in such a way that 
all our societies benefit? Is that a conceivable thing to do?
    Mr. Huang, do you have any thoughts?
    Mr. Huang. Let me get to this question maybe from a 
slightly different perspective. I want to emphasize that there 
are similarities between China and the rest of East Asia in 
terms of their increasing export capacity.
    But there is a critical difference. That difference 
benefits the United States far more than the growth of Japan 
and other East Asian economies in the 1960s and 1970s. That is 
the role of foreign direct investment. Mr. Chairman, you are 
exactly right that technology is moving in such a way, the 
communication costs are coming down, air transport, shipping, 
all these things are becoming 
extremely cheap.
    So, to the extent that some of these manufacturing 
operations are going to migrate out of the United States, then 
this country is faced with two choices. One is do you want to 
lay a claim on the assets abroad, such as in China or do you 
want to face the competition from the Chinese companies owned 
and operated by the Chinese themselves?
    Now, foreign direct investment is enabling the United 
States to lay a claim on this incredible growth of industries 
in China. 
Motorola alone, in the 1990s, just one company, accounted for 
50 percent of Chinese electronics exports to the United States. 
The shareholders of Motorola benefit from this. The affiliates 
of Motorola benefit from this, because many of these products 
come back to the United States to feed into the next chain of 
production, whereas, the United States was not able to do that 
vis-a-vis Japan, vis-a-vis Korea.
    So, China's growth is not achieved at the expense of 
America at large. I recognize that there are manufacturing 
industries in the United States, that labor is suffering. But 
there are a lot of other people who benefit from this. The Wal-
Mart example is a very good one. I shop at Wal-Mart, and as far 
as I can see there are a lot of Americans shopping at Wal-Mart.
    They benefit tremendously from the production of goods in 
China in two ways, financially, because American citizens have 
a financial claim over these assets in China, and second, they 
benefit 
because they can buy these goods at very cheap prices.
    Chairman Leach. Dr. Lau.
    Mr. Lau. Mr. Chairman, if I just might add, very briefly. 
One interesting thing is that the United States and China are 
actually complementary in terms of their industrial mix. China 
does not export anything that we export. We do not export 
anything that China exports. So, it is actually a good fit.
    Representative Levin. How about steel?
    Mr. Lau. I mean, China is now importing a lot of steel.
    Representative Levin. They exported it in 1997.
    Mr. Lau. That is right. There might be some exceptions, but 
by and large the economies are very complementary. We are good 
at high-tech, they are good at assembly.
    I think that is why there is actually a much better basis 
for these two economies to work together than, for example, 
between the United States and Japan, where there is actually 
much more competition. So I think one should be able to fashion 
a win-win strategy.
    Now, I accept that there are transition pains on both 
sides, because there will be job displacement on both sides. 
For example, General Motors establishing a shop in Shanghai is 
going to drive out some local Chinese automobile firms. Many of 
them have to go.
    So it is really the adjustment costs that we need to think 
through, as to how we take care of the displaced workers, both 
in this country and in China.
    I think that there should be enough gravy generated that we 
can actually fashion something that could work. I actually try 
to promote an idea. We know that textile factories in the 
Carolinas are doing terribly. I actually floated the idea that 
perhaps some large textile company in China should come and 
take a look, see if they could take over some of them, take 
over the workers, use the brand names, continue the brand names 
and sort of keep the companies going.
    I think there are really ways of making this work so that 
it would actually be mutually beneficial. It does not have to 
be a trade war. It is much better to increase exports of both 
countries than to reduce exports of both countries to the 
other. Thank you.
    Chairman Leach. Ms. Pearson, do you want to add anything? 
Is there hope?
    Ms. Pearson. Well, I think that it is a difficult 
situation. It is fundamentally difficult. But what troubles me 
about so much of the debate that I hear now, particularly about 
the insertion of this currency manipulation argument, is that 
if you are concerned about the loss of American manufacturing 
jobs to pressure China to float its currency, it does not solve 
the problem.
    The loss of American jobs or China's taking over of 
manufacturing is, as many have said but it does not seem to be 
heard in this debate, taking over jobs that have come to it 
from the rest of East and Southeast Asia. So, it is troubling 
to hear the argument that if China floats its currency it is 
going to save American manufacturing. I think that kind of 
broad-brush approach to the problem is difficult.
    Again, I have not heard it too much from this body, but 
when I read the media and when I hear much of what is going on 
in the political discussion and the discussion among pundits in 
Washington now, that assumption frequently seems to be made.
    Chairman Leach. Let me just say, I do not think there is 
anyone that thinks that simply changing the currency saves the 
jobs. I do think that there is an equity issue that is not 
trivial. It comes back to economics.
    Several of you are economists, whether you believe in fixed 
exchange rates or flexible exchange rates, and whether or not 
there are models of manipulation based on fixed rates that 
benefit some parts of a society and disadvantage other parts. 
That implies both within the two societies that are involved in 
this circumstance, or the multitude of societies that are 
involved. I think the case for moving the direction of flexible 
exchange rates is good for all 
parties.
    I also think that it is a more stable system and that 
experiments with trying to keep things fixed, which implies 
stability, is actually a very unstable situation. I think that 
is mainstream American modern economic thinking. I do not think 
that is aberrational thinking.
    Although there are cases in which you have economists who 
have argued that sometimes there is a case for a country to 
have a fixed exchange rate using the United States as a 
currency base. We experimented with that with Argentina; not 
only did it not do well in Argentina, it set a real cloud over 
America's economic relations with the rest of Latin America.
    So I am not arguing for any precise number, but I do argue 
very strenuously for flexible exchange rate regimes as being 
helpful to all modern societies. I think you also have, from 
China's perspective, a circumstance where, if you have flexible 
exchange rates, it is like the WTO.
    You enter into a fair trade regime and you protect your 
ability, if you have the ability, to do things better than 
someone else. If you do not have that ability, you are 
unprotected. So I think it is something that one should not be 
apologetic about arguing for. I think it is very much in the 
interest of world society.
    Even though Sandy's brother notes that it is not a very 
compelling argument in countries like Japan or China about 
protecting the public, I think it is a protection to public 
treasuries not to have fixed exchange rate regimes that get 
artificially propped up because the sum total of trade can 
overwhelm those public efforts, so it is a reasonable thing to 
assert and affirm.
    Ms. Pearson. In terms of where the economic system 
eventually will get in China, I think that is very reasonable. 
Indeed, it seems to me that Chinese banking officials and very 
high-level officials have argued for many years that the goal 
is to eventually float the currency. The real debate is over 
whether it should be done tomorrow, or by 2005, or 2010. That 
is probably where the disagreement comes on it from both the 
Chinese side and this side.
    Chairman Leach. Both the Chinese and what side?
    Ms. Pearson. That is where it comes from both sides, the 
Chinese side and the U.S. side.
    Chairman Leach. I want to be careful. I think that is where 
the debate comes from, the Chinese side. I do not think it is 
the position of the U.S. Government to assert 2010. I think 
that a general frame of reference is one for competition in 
exchange rates. So I do not think it is a both-sided thing.
    Ms. Pearson. I understand the U.S. Government is not giving 
a date of 2010. I am saying that the dispute is probably over 
the pace at which we get there.
    Mr. Huang. Also, I think it is sequencing. It is timing as 
well as sequencing. The real flow of the currency, at a time 
when Chinese financial institutions are struggling with 50 
percent bad loans on their balance sheet, the state-owned 
sector is in a huge mess, do you liberalize the capital 
controls at this particular juncture?
    So the timing is actually conditional upon the sequence of 
reforms that the government has to undertake. I do not think it 
is in the interest of the United States to engineer something 
that may lead to a higher probability of a financial crisis in 
China.
    So pegging the currency actually serves two purposes. One, 
is to keep the Chinese currency cheap in order to increase 
China's competitiveness. But this is a function that is being 
performed now.
    In 1997, the pegging of the Chinese currency served to 
prevent a massive depreciation of Chinese currency that would 
have destabilized Asia in a very dramatic fashion as Thailand, 
South Korea, and other Asian countries went into a financial 
crisis.
    So I think there is a need to be cautious about when to do 
this and what kind of unanticipated effects can be associated 
with such a dramatic change in the currency pegging system.
    Representative Levin. Let me just say, I guess we are 
winding up. I think we understand there are complexities, but 
they sometimes tie us into knots. I do not think that that is 
where we should be.
    The same, if I might say so, is to Professor Lau's argument 
about transition. First of all, I think in some sectors China 
is moving to value added production and more rapidly than some 
thought. It is not that they are simply assembling things that 
come from elsewhere.
    That was true some years ago, but I think it is 
increasingly changing. There is more talent there than we give 
credit for, more engineers there than we sometimes understand.
    Second, I think people in this country are asking--and it 
is a legitimate question--transition to what? The fact that 
there is no answer here in terms of job loss, I think, 
illustrates the question of ``transition to what'' is an 
important issue that we need to consider.
    We do not have time, but the textile and apparel industry 
is a good example. There is a fear not only in the United 
States, but in the Caribbean generally that China, once the 
quotas are lifted, will capture 75, 80 percent of the market, 
and not simply by assembling materials that come from 
elsewhere. So it may be a small part of the GDP of the United 
States, but it would be a pretty large part of the GDP of 
Caribbean nations.
    But we will have another hearing, right?
    Chairman Leach. I want to have just one more question. The 
three of you are experts from where you reside on the subject 
of academics. I raise this because, having just been to the Far 
East, I am really struck by the sensitivity of the issue of 
visas and how we go about issuing them, and what could occur 
come next January when new rules go into effect.
    I am a big believer that education is an export item, as 
well as a cultural circumstance. The United States has begun 
the process of restricting our own exports, which is a bizarre 
situation.
    Now, we all recognize the new order in the world and the 
new challenges to the world, and we all recognize the 
difficulty in making exceptions in some parts of the world to 
the rules on visas.
    But I am worried sick that the United States is going to 
(a) lose an export market, and (b) cause real kinds of dissent 
in parts of the world that we do not like to see dissent 
increase.
    Now, from your perspectives at MIT, the University of 
Maryland, Stanford, are you sensing this sort of thing 
developing, or have I exaggerated that prospect?
    Professor Lau.
    Mr. Lau. This is a problem. We noticed that a lot of 
students are contacting us about not having enough time. We 
actually sometimes have to call or write our consulates, hoping 
to move and expedite the process.
    But I think I would say, with sufficient notice, we can 
probably do it. I mean, we just have to move the dates up a 
little bit.
    But I think what we could also do to make it easier is 
perhaps to somehow raise the visa fees and hire more people, 
because it increases through-put. There is really no reason why 
someone who is coming to either Stanford, MIT, Berkeley, 
whichever, they have honest-to-God admissions and they are good 
students, why we should not try to process them as quickly as 
we can, subject to our rules.
    I think having more people would make it possible, because 
right now the big bottleneck is scheduling the interviews, I 
understand. Everybody has to be interviewed.
    Chairman Leach. In addition, they are going to be required 
to be fingerprinted, or other kind of biological identifier.
    Mr. Lau. I think that is all right. I mean, I do not think 
people would object to fingerprinting, or retina scanning, or 
whatever. I think that actually is a process that I think every 
country is moving to, because I think that basically eliminates 
counterfeiters. So I think people can understand that. But I 
think it delays the timing.
    Chairman Leach. That matters the most.
    Mr. Lau. Yes.
    Chairman Leach. Where the good students at Stanford and 
Berkeley, and the great students at the University of Iowa. Is 
that what you are saying?
    Mr. Lau. Right. Exactly.
    Chairman Leach. Ms. Pearson.
    Ms. Pearson. My concerns are actually very similar to 
yours. We do lose very good students who do a lot for us when 
they are here, and in important ways serve as ambassadors or 
modes of communication between the United States and China when 
they return home. I am concerned about it.
    Chairman Leach. Thank you.
    Dr. Huang.
    Mr. Huang. I think this is an extremely important issue. 
There was a story in the New York Times about a Chinese doctor 
who was unable to come to a medical conference in the United 
States.
    The reason I bring up this story, is that the date of the 
publication of that story is very significant. It appeared on 
September 10, 2001. The next day, out of 19 hijackers of these 
planes, I think half of them did not really need a visa to come 
to the United States.
    So these kinds of restrictions are being placed on the 
Chinese, extremely talented people who come to study, who then 
may decide to stay as I have, but we are continuing to make 
contributions to both the United States and to China. Many of 
these people are not allowed to come. The educational programs 
are not just benefiting from this kind of exchange financially.
    The United States gains a tremendous amount of benefit in 
terms of the values, in terms of knowledge that we impart to 
the younger generation of Chinese. I would urge the U.S. 
Government to keep that in mind when it designs its policies on 
this issue. Thank you.
    Chairman Leach. Well, thank you all very much. Thank you. 
Let me bring this hearing to an end and say we are particularly 
appreciative of the academic witnesses, particularly the two of 
you that have come from far distances. Ms. Pearson, we consider 
you a home town source of great value.
    Thank you all very much.
    [Whereupon, at 2:05 p.m. the hearing was concluded.]
                            A P P E N D I X

=======================================================================


                          Prepared Statements

                              ----------                              


                 Prepared Statement of Henry A. Levine

                           september 24, 2003
    Mr. Chairman and members of the Commission, thank you very much for 
inviting me to participate in this hearing.
    The Department of Commerce is dedicated to making sure ``China is 
playing by the rules'' and we continue active efforts, in coordination 
with U.S. companies and other U.S. agencies, to that end. I recently 
returned from China with Assistant Secretary William Lash. We worked on 
preparations for Secretary Evans's October trip to China and met with 
senior officials to discuss China's WTO compliance record and other 
bilateral trade issues. We stressed the need for China to implement its 
WTO commitments fully and on time.
    The stakes involved in seeing that China ``plays by the rules'' are 
large. China is our fourth largest trading partner. Bilateral 
merchandise trade reached $147.2 billion in 2002. Our imports from 
China have been growing rapidly. China overtook Japan to become our 
third largest source of imports last year, and surpassed Mexico in July 
to become our second largest source of imports. Because our imports 
from China are more than five times greater than our exports, China has 
become our largest deficit-trading partner. The bilateral trade 
deficit, which hit $103 billion in 2002, reached $65 billion in the 
first 7 months of this year.
    While our deficit with China has continued to soar, it is also 
worth noting that since 2001, China has been by far our fastest growing 
export market among our top 10 trading partners. Although our exports 
to the world declined 7 percent in 2001, 5 percent last year, and rose 
less than 3 percent in the first 7 months of this year, our exports to 
China surged 19 percent in 2001, 15 percent last year and more than 22 
percent in January-July. Along with the United States, China now 
accounts for most of the current growth in the world economy.
    As you know, the Administration has placed much emphasis on 
responding to the concerns of the U.S. manufacturing sector. In March 
2003, Secretary Evans directed the Commerce Department to lead a 
comprehensive review of the issues influencing long-term 
competitiveness of U.S. manufacturing, and to outline a strategy for 
ensuring that government is doing all it can to create the conditions 
for manufacturers to thrive. This review will culminate in a report to 
be released later this fall. In developing this report, Commerce 
Department officials held roundtable discussions in more than 20 cities 
across the country--from Manchester, NH to Columbus, OH to Detroit to 
Los Angeles--meeting with manufacturers in the aerospace sector, autos, 
semiconductors, pharmaceuticals, among others.
    In response to the concerns we have heard, Secretary Evans has 
already announced several new initiatives, including the creation of an 
Assistant Secretary focused on the needs or manufactures supported by a 
new Office of Industry Analysis to focus on the needs of American 
manufacturers, the creation of a new Assistant Secretary for Trade 
Promotion to boost our exports, and the establishment of an Unfair 
Trade Practices Team to track, detect and confront unfair competition.
    During the roundtable discussions, no country raised more attention 
as a source of concern than China. Our manufacturers complained about 
rampant piracy of intellectual property; forced transfer of technology 
from firms launching joint ventures in China; trade barriers; and 
capital markets that are largely insulated from free-market pressures. 
We have also heard rising concerns about the pace and direction of 
China's implementation of its WTO commitments in areas such as 
transparency, IPR protection, trading rights and distribution services, 
agriculture, and financial services.
    Americans are willing to compete, on even terms, with any country 
in the world but we will not stand for unfair competition. We will not 
look the other way or wait idly. As the Secretary stated in a recent 
speech to the Detroit Economic Club, ``American manufacturers can 
compete against any country's white collars and blue collars, but we 
will not submit to competing against another country's choke collars.''
    To ensure that China honors its commitments and that U.S. companies 
benefit from these opportunities, we have adopted an aggressive and 
multi-pronged approach. We are going to target unfair trade practices 
wherever they occur. We are exploring the use of new tools to expand 
our trade promotion activities related to China. We are expanding our 
efforts to engage Chinese officials to help make sure they ``get the 
rules right'' as they continue their massive task of restructuring 
their economic system.
    In the area of intellectual property rights (IPR) protection, 
despite China's commitments to cracking down on rampant piracy, fake 
CDs, DVDs and pharmaceuticals continue to flood the market, costing us 
estimated $20-25 billion annually. In fact, the Business Software 
Alliance estimates that software piracy rates in China exceed 90 
percent. In response, we continue to insist that the Chinese government 
take the steps necessary to bring these problems under control. We have 
raised specific IPR concerns at our meetings with senior Chinese 
government officials. Through the annual Special 301 process, working 
with our colleagues in other agencies, we continue to closely monitor 
China's IPR conditions. To make sure that China has the tools to 
implement its commitments we have organized a series of seminars with 
Chinese officials conveying U.S. views on how best to increase criminal 
enforcement of IPR violators and stop cross-border trade in pirated 
products. We think China can and should do better in these areas. We 
will continue to press for this goal.
    In our manufacturing roundtables many companies have expressed 
concern over the exchange rate of the Chinese Yuan. This administration 
believes that currency values should be set by free-market forces. 
Secretary Snow delivered exactly that message to the Chinese government 
3 weeks ago.
    While continuing our focus on China's WTO implementation and other 
trade practices, we will continue to enhance the ability of U.S. 
businesses, especially small and medium-sized businesses, to compete in 
China. We are launching ``Doing Business in China'' seminars in cities 
across the country, which address small business concerns pertaining to 
the Chinese market. We are enhancing our efforts to insure that U.S.-
developed technical standards are accepted in China just as they are 
accepted elsewhere internationally. We are exploring ways to develop 
more trade leads in China and to provide even more targeted information 
on China opportunities for companies in the United States.
    Combined with these domestic efforts, we regularly engage Chinese 
government officials to ensure trade agreement compliance and market 
access for our products and services. Secretary Evans will visit China 
in October to advance U.S. interests and ensure U.S. companies face a 
level playing field in our economic relations with China. We will have 
another opportunity to raise outstanding issues during the 15th U.S.-
China Joint Commission on Commerce and Trade (JCCT). Secretary Evans 
has issued an invitation to host China's Minister of Commerce Lu in 
Washington for the JCCT by the end of this year. We are still awaiting 
an official response.
    Thank you for devoting this hearing to these important issues, and 
I welcome your questions.
                                 ______
                                 

              Prepared Statement of Charles W. Freeman III

                           SEPTEMBER 24, 2003

    Thank you for inviting me to appear before you today to discuss the 
Administration's perspectives on the United States' trade relationship 
with the People's Republic of China and, in particular, the topic of 
China's WTO implementation.

             CHINA'S IMPLEMENTATION OF ITS WTO COMMITMENTS

    China acceded to the WTO on December 11, 2001, after 15 years of 
negotiation with the United States and other members of the WTO and its 
antecedent, the General Agreement on Tariffs and Trade. China's 
accession was a watershed event for both China and the United States. 
By committing to implement the WTO's market access, national treatment 
and transparency standards; protect intellectual property rights; and 
limit the use of trade-distorting domestic subsidies, China promised to 
deepen and consolidate the market-oriented economic reforms first 
initiated in the years following the death of Mao Zedong. For the 
United States, China's WTO accession not only promised unprecedented 
market access to one of the world's most intriguing, and fastest 
growing, economies; it also provided a forum through which the United 
States and China could mediate and resolve trade disputes without the 
use of unilateral measures. At its heart, China's WTO accession 
represents a commitment by China to play by the established rules of 
international trade both at the border and internally, and thus was a 
fundamental step toward establishing the primacy of the rule of law in 
China.
    China has now been a WTO member for more than 21 months. In that 
time China has completed much of the nuts-and-bolts work of WTO 
implementation: amending and promulgating thousands of laws and 
regulations to effect its WTO commitments, establishing new 
transparency procedures in many national and sub-national agencies, and 
reducing tariffs to their committed levels. This work has taken place 
against a challenging political and social backdrop: since December 
2001 China 
underwent a major leadership change; passed through a harrowing 
national SARS epidemic; faced unprecedented protests by some 600,000 
Hong Kong citizens; and generally has confronted the host of 
dislocations inherent in its transition from a planned to a more 
market-oriented economy.
    Whether or not China's domestic difficulties have had an impact on 
its ability to implement its WTO commitments in both letter and spirit, 
the Administration has noted a variety of shortcomings in WTO 
implementation over the course of the past 21 months. As highlighted in 
our 2002 Report to Congress on China's WTO Compliance, covering China's 
first year of WTO membership, China's WTO implementation was most 
problematic in the areas of agriculture, services, enforcement of 
intellectual property rights and transparency. Although we have seen 
progress in some of these areas, they still remain areas of serious 
concern. At the same time, other areas of concern have begun to emerge. 
For example, China's use of certain tax policies to favor domestic 
production or provide incentives to increase exports has developed into 
a significant source of concern. In some sectors that the 
Administration has engaged with China and resolved WTO trade-related 
concerns, new problems have emerged in place of those resolved through 
engagement.
    In our experience, China's compliance problems are occasionally 
generated by a lack of coordination among relevant ministries in the 
Chinese government. Another source of compliance problems has been a 
lack of effective or uniform application of China's WTO commitments at 
local and provincial levels. China is taking steps to address both of 
these concerns, through more effective inter-ministerial mechanisms at 
the national level, and through a more concerted effort to reinforce 
the importance of WTO-consistency with sub-national authorities. In 
other cases, however, compliance problems involve entrenched domestic 
Chinese interests that may be seeking to minimize their exposure to 
foreign competition. These problems are difficult to deal with, and 
even after the Administration has engaged with China and resolved our 
concerns, new problems have often emerged in place of those resolved 
through engagement.
    The central lesson the Administration has learned with respect to 
China's WTO implementation is that the years of tough negotiations that 
led up to China's WTO accession were no accident. We will need to match 
the painstaking efforts and persistence of those negotiators in order 
to ensure that China implements its commitments fully. While providing 
an exhaustive inventory of bilateral trade concerns is beyond the scope 
of this statement, I would propose to highlight a number of central 
concerns and the ongoing efforts of the Administration in pursuing 
their resolution.

                              AGRICULTURE

    China's potential as a market for U.S. exports of bulk agricultural 
commodities was a key factor in U.S. support for China's WTO accession 
and grant of Permanent Normal Trade Relations (PNTR) status to China. 
While bumper harvests of some crops in China in 2002 may have limited 
the commercial potential of some U.S. exports, China's attempts to 
restrict certain agricultural imports has been an ongoing theme of the 
first 21 months since China's WTO accession. The use of--or even the 
threat to use--questionable GMO standards and sanitary and 
phytosanitary (SPS) measures to restrict imports of some products for 
alleged health and safety concerns has frustrated efforts of U.S. 
agriculture traders, most notably in the case of soybeans. In the case 
of those bulk agricultural commodities subject to negotiated tariff-
rate quotas (TRQs) in China, the setting of sub-quotas, use of Catch-22 
import licensing procedures, allocation of TRQs in commercially 
unviable quantities and a lack of transparency in TRQ allocation and 
management have combined to disturb what should be a ready market for 
U.S. exporters, particularly in the case of cotton.
    After the efforts of Ambassador Zoellick, Agriculture Secretary 
Veneman and others in the Administration, the commercial impact of 
these potential barriers was contained. U.S. exports of soybeans topped 
$1.2 billion--a record--and cotton sales were already 8-10 times 
greater than in any previous calendar year by July, 2003. Nevertheless, 
systemic problems with both GMO and SPS regulation continue to hang 
like a cloud over the marketplace, and a negotiated settlement to our 
concerns with China's TRQ system has yet to be fully implemented. These 
and other emerging concerns, such as China's apparent use of supports 
to promote agricultural exports, will require continued vigilance and 
engagement by the Administration in order to prevent a disruption in 
this important trade.

                      INTELLECTUAL PROPERTY RIGHTS

    In the year leading up to WTO accession, China did make significant 
improvements to its framework of laws and regulations protecting 
intellectual property rights (IPR). However, the lack of effective IPR 
enforcement in China is a major obstacle toward a meaningful system of 
IPR protection. IPR problems run the gamut, from rampant piracy of film 
and other entertainment products, to sophisticated software and 
semiconductor products, to counterfeiting of consumer goods, electrical 
equipment, automotive parts and pharmaceuticals. IPR infringements not 
only have an economic toll; but also present a direct challenge to 
China's ability to regulate those products that have health and safety 
implications for China's population and international purchasers of 
such products. While a domestic Chinese business constituency is 
increasingly active in promoting IPR protection for self-interested 
reasons, the problem is immensely widespread. If significant 
improvements are to be achieved on this front, China will have to 
devote considerable resources and political will to this problem, and 
there will continue to be a need for sustained efforts from the United 
States and other WTO members.
    The United States has had an ongoing dialog with China on IPR 
matters for a number of years, including through an annual series of 
bilateral meetings chaired by USTR and its Chinese counterpart, the 
Ministry of Commerce, the next series of which is scheduled for 
November this year. Ambassador Zoellick, Secretary Evans, and, most 
recently, Secretary of Treasury Snow have used every occasion to press 
China on the importance of a more effective regime for IPR enforcement. 
In the view of the Administration, the key to achieving this end will 
be for China to increase deterrent-level criminal penalties for IPR 
violators, demonstrate a willingness to increase prosecution and 
punishment of IPR offenders, to lower thresholds for criminal 
prosecution, to increase resources and devote more training for 
enforcement in all parts of China, and to establish more effective 
communication procedures 
between relevant officials of China's courts and investigative units, 
the Supreme People's Procuratorate and China's lawmaking bodies.

                                SERVICES

    Meanwhile, concerns arose in many services sectors, principally due 
to transparency problems and China's use of prudential requirements 
that exceed international norms. The United States and China have had 
reasonably cooperative talks to resolve these concerns in many of the 
affected sectors, but progress has been slow and not without 
frustrations. In some cases, such as express courier services, much 
progress was made toward resolving regulatory concerns in 2002, but 
problematic regulations remain under consideration, even if they have 
yet to be implemented. In other cases, such as implementation of 
China's commitments on branching by insurance companies, the United 
States and China remain at odds despite a longstanding cordial and 
otherwise productive dialog with Chinese regulators.

                        VALUE-ADDED TAX POLICIES

    China has increasingly used value-added tax (VAT) policies to 
encourage domestic industrial or agricultural production in a number of 
sectors. In the case of semiconductors, China's policy of providing 
rebates of VAT to domestic semiconductor producers disadvantages U.S. 
exports and raises significant WTO compliance concerns. In the case of 
fertilizer, China exempts from the VAT fertilizers that compete 
directly with the principal U.S. fertilizer export, a practice that is 
difficult to justify by WTO rules. In addition, we also have received 
reports that China has been rebating the VAT paid on domestically 
produced agricultural goods, including corn, and even that China is 
rebating the VAT in such a way as to subsidize exports--a 
particularly serious charge, given China's WTO commitment to eliminate 
export subsidies. The Administration has engaged China on all these 
practices, and will continue to pursue the elimination of 
discriminatory or trade-distorting VAT policies through appropriate 
channels in Beijing, Washington and Geneva.

               CHINA'S WTO TRANSITIONAL REVIEW MECHANISM

    China was admitted to the WTO on somewhat unique terms. Rather than 
completing the process of implementing its WTO commitments as a pre-
condition of WTO membership, China was admitted to the WTO by 
committing to implement them. In large part to monitor China's 
transition toward full implementation, the WTO conducts an annual 
review of China's implementation progress: the Transitional Review 
Mechanism (TRM). This review, which will take place in 8 of the next 9 
years in 16 subsidiary bodies as a lead-up to the year-end meeting of 
the WTO's General Council, is an opportunity for other WTO members to 
engage China on the extent to which it has complied with its 
commitments and to clarify China's trade practices. The first year of 
the TRM was marked by some misunderstanding between China and other WTO 
members as to expectations of China at the TRM, but communication 
clearly improved as the process unfolded. The Administration expects a 
smoother and more useful TRM in year two and beyond.

                                IMPORTS

    The trade imbalance between the United States and China topped $103 
billion in 2002, and threatens to climb higher in 2003. I should point 
out that this is in part a result of the expansion of our overall trade 
relationship: While imports from China out pace those from all other 
WTO members, China is also our fastest growing export market. In 2002 
our exports to China were over $22 billion, and, with exports through 
July 2003 up 22.7 percent compared with the equivalent period in 2002, 
China has become our 6th largest export market. Nevertheless, the rapid 
expansion of trade between our two countries has inevitably lead in 
some cases to competition between domestically produced goods and 
imports in both our markets. To the extent China unfairly protects its 
domestic producers to the detriment of competition from United States, 
the Administration continues to be prepared to assert U.S. interests. 
To the extent imports from China disrupt U.S. markets, the 
Administration is fully prepared to assert the rights of the United 
States under China's WTO accession agreement.
    As part of China's WTO accession package, China agreed to two 
separate China-specific safeguard mechanisms to allow WTO members to 
cope with market disruptions caused by increasing economic integration 
with China, particularly during the period when China is still phasing 
in its WTO commitments. One such mechanism, the product-specific 
safeguard, was codified as Section 421 of the Trade Act of 1974, as 
amended, and is available until December 11, 2013. Since the 
implementation of Section 421, three petitions have been brought 
requesting import relief. In one case, the International Trade 
Commission found that our domestic producers' market had not been 
disrupted by imports from China. In two other cases, while the ITC 
found market disruption, the President determined that the adverse 
impact on the U.S. economy was clearly greater than the benefits from 
providing import relief. While to date no import relief has been 
granted under Section 421, the President, in his most recent 
determination, reiterated his commitment to using the safeguard when 
the circumstances of a particular case warrant.
    The second safeguard agreed to by China as part of its WTO 
accession package is specific to textiles, and allows WTO members the 
opportunity to invoke limited import relief--specifically a 7.5 percent 
cap on growth in imports of a given textile category for up to 1 year 
(6 percent for wool products)--until December 31, 2008. The 
Administration is currently reviewing three requests under this 
safeguard mechanism, and initial determinations will be forthcoming in 
mid-November of this year.

                U.S.-CHINA DIALOGUE ON ECONOMIC MATTERS

    The Administration maintains three formal dialogs with Chinese 
ministries. The Commerce Department chairs meetings of the Joint 
Commission on Commerce and Trade; the Treasury conducts meetings of the 
Joint Economic Commission with the Chinese Ministry of Finance; and 
USTR chairs an interagency Trade Dialogue with counterparts from the 
Ministry of Commerce and relevant other Chinese agencies. Like many of 
the informal contacts, these formal occasions are opportunities not 
merely to discuss bilateral and multilateral trade and economic 
matters, but are themselves action-forcing events at which significant 
progress can be achieved. They also act as an early warning system on 
trade problems--providing an opportunity to resolve issues before they 
become broader bilateral irritants.
    In addition to these formal processes, the Administration meets 
frequently on both the Cabinet and sub-cabinet level with senior 
Chinese officials, and uses such meetings to press the importance of 
economic issues with Chinese counterparts. In the case of USTR, 
Ambassador Zoellick meets or speaks via telephone with PRC Minister of 
Commerce Lu Fuyuan on a regular basis, has been to China twice since 
December 11, 2001, and plans to travel to China again for bilateral 
discussions next month. Ambassador Josette Sheeran Shiner recently 
confirmed as Deputy USTR, plans to continue an active dialog with her 
counterparts, and other USTR officials meet regularly with Chinese 
officials on bilateral trade concerns, whether in Washington, Beijing, 
or at the WTO. These exchanges are critical opportunities to 
advance bilateral and multilateral trade and economic matters, and have 
proven effective in making progress on key U.S. concerns.

                               CONCLUSION

    Mr. Chairman and members of the Commission, thank you for providing 
me with the opportunity to testify. I look forward to your questions.
                                 ______
                                 

                  Prepared Statement of Gary C. Martin

                           SEPTEMBER 24, 2003

    Thank you for the honor and opportunity to address the 
Congressional-Executive Commission on China.
    The North American Export Grain Association (NAEGA), established in 
1912, is comprised of private and publicly owned companies and farmer-
owned cooperatives involved in and providing services to the bulk grain 
and oilseed exporting industry. NAEGA member companies ship practically 
all of the bulk grains and oilseeds exported each year from the United 
States. The Association's mission is to promote and sustain the 
development of commercial export of grain and oilseed trade from the 
United States. NAEGA acts to accomplish this mission from its office in 
Washington DC, and in markets throughout the world. NAEGA has a joint 
operating and service agreement with the National Grain and Feed 
Association (NGFA), whose 1,000 member companies consist of all sectors 
of the U.S. grain, feed processing and exporting business. NGFA member 
companies operate approximately 5,000 facilities that handle more than 
two-thirds of all U.S. grains and oilseeds. NGFA and NAEGA coordinate 
policy and government representation on trade related issues that 
affect economic prospects of the industry. This enables the 
organizations to speak in a unified voice to government and to the 
industry's domestic and international customers.
    Our trade relationship with the People's Republic of China is of 
great importance to the economic success of U.S. agriculture. 
Compliance with the World Trade Organization (WTO) rules is a 
foundation of successful economies around the world as well as critical 
element in a successful trade relationship with China. The North 
American Export Grain Association has a long history of facilitating 
the export of U.S. wheat, corn and soybeans to China. We are very much 
engaged in resolution of concerns related to several questions to be 
addressed in today's hearing. In particular, I would like to focus on 
three questions: Which Chinese government policies have made Chinese 
exports competitive? Which remaining non-tariff barriers hinder market 
access for U.S. imports into China? and, what type of U.S. Government 
policy changes could help in changing conditions in China?
    By most measures, China's efforts to meet it's WTO commitments to 
reduce both tariff and non-tariff barriers in the agricultural sector 
have been met with mixed results. There has been welcome progress in 
some key areas such as tariff reductions. Unfortunately, many issues 
that amount to non-tariff barriers continue to limit progress under 
China's WTO commitments and exports to the Chinese marketplace. 
However, from the perspective of U.S. agriculture and the grain trade, 
the impact of China trade is difficult to overstate. Likewise the 
implementation of China's WTO commitments continues to have a profound 
impact.
    To put some perspective on the questions under consideration by the 
Committee, we should acknowledge the recent growth in agricultural 
exports to China. On a July through June basis, we have seen total 
value of U.S. agricultural exports to China rise from less than $500 
million in 1999 to almost $2.25 billion in 2003. Since China was 
accepted into the WTO (December 2002), it is safe to say that U.S. 
agriculture exports to China are on a pace to double in value.
    When China imports the impact can be quite dramatic. Our soybean 
sales to China this year may exceed $2 billion. U.S. soybean exports to 
China represent not only a very large percentage of overall U.S. 
soybean exports but also big piece of our overall agricultural export 
value and very large, market dominating share of world trade in 
soybeans.
    When China stops imports or fails to meet expectations, the result 
is a large negative impact on our agricultural markets. A short 20-30 
day interruption in soybean trading (due to uncertainty over 
biotechnology policy) last year may have resulted in up to $100 million 
in lost U.S. sales. Expectations of large export markets for U.S. corn 
and wheat simply have not been met. While import demand for these crops 
is largely dependent on domestic supply, we think it is clear that WTO 
non-compliant policies of the Chinese government have stimulated 
production, reduced access and, in the case of corn, subsidized 
exports. For wheat, calendar year to date exports total over 1 million 
tons--up 104 percent from 2002. Chinese wheat imports have fallen this 
year by 60 percent to about 200,000 tons. Chinese corn exports have 
recently overtaken several long term U.S. corn export markets. This 
year China has exported 50 percent more corn than it did in the same 
period last year--a calendar year to date total of over 9 million tons. 
Our expectations were for Chinese membership in the WTO to result in 
significant imports from the United States of both corn and wheat.
    As China continues to transition its economy and agricultural 
policies, we expect China will continue progress toward a policy more 
accommodating to international trade. I believe China recognizes the 
need to further open agricultural markets to provide for enhanced food 
security and economic well being. The difficulty is in the transition 
from a centrally planned and managed economy to an economy that 
benefits from allowing market forces to prevail. For agriculture, as we 
too have experienced, this transition can be especially difficult.
    In response to these three questions: Which Chinese government 
policies have made Chinese exports competitive? Which remaining non-
tariff barriers hinder market access for U.S. imports into China? and 
what type of U.S. Government policy changes could help in changing 
conditions in China?--There are several key issues related to trade in 
agricultural products that need to be addressed:

 Uncertainty regarding biotech regulations and the issuance of 
    permanent safety certificates for biotech products. Much progress 
    has been made in this regard. Our industry is especially 
    appreciative of the effective and timely response of President Bush 
    and his Administration in moving this complex and difficult issue 
    very close to resolution.
 Labeling and information requirements on meat and poultry 
    products that increase export costs without enhancing food safety.
 Chinese adherence to the Agreement on the Application of 
    Sanitary and Phytosanitary Measures (the SPS Agreement). Particular 
    concerns regarding the failure to utilize the International Plant 
    Protection Convention and ``zero tolerance'' pathogen standards 
    that are neither science-based or practical, as well as undue 
    quantitative restrictions on meat and poultry imports.
 Administrative interference with import trade by China's 
    quarantine authorities and Ministry of Commerce, including 
    requiring import permits before signing 
    purchase contracts and making shipment. Most administrative 
    measures lack transparency and appear to be used to institute short 
    term quotas established to address political concerns.
 Significant export subsidies for agricultural products, 
    particularly corn.
 A range of problems with the implementation of China's 
    promised tariff-rate quota (TRQ) system, including a lack of 
    transparency, delay in the announcement of quotas, granting of 
    insignificant and uneconomic quotas, imposition of restrictions 
    that are not required of domestic producers or merchants, and 
    inclusion of quotas for mandatory re-export.

    While China has eliminated or reduced some tariff barriers, the 
benefits from these actions can be quickly offset by continued non-
tariff barriers that restrict trade into China, create significant 
marketplace uncertainty and discourage further foreign investment. The 
agricultural TRQ issue has the potential to be the first case against 
China under the WTO dispute resolution system. U.S. industry has 
consistently called for science-based, permanent rules for genetically 
modified organism (GMO) imports, a transparent TRQ system, and an end 
to agricultural export subsidies.
    The progress made by the governments of China and the United States 
through collaborative work to reduce these unjustified barriers to 
agricultural imports has been significant and is certainly in the best 
interest of both countries and the modernization of Chinese food 
production.
    We need to aggressively focus the attention and improve China's 
compliance with the WTO in three areas: (1) the regulatory practices of 
Chinese State Administration of Quality Supervision and Inspection and 
Quarantine (AQSIQ); (2) the complete and final elimination of 
agricultural export subsidies; and (3) the implementation of 
agricultural TRQ systems.

                       AQSIQ REGULATORY PRACTICES

    U.S. soybean, cotton and meat traders continue to experience 
significant restrictions on exports of products to China stemming from 
AQSIQ's posture on the issuance of Import of Animal and Plant 
Quarantine permits and its inspection procedures. Chinese quarantine 
regulations require importers to obtain import permits before entering 
into purchase contracts and effecting shipments. With import permits 
valid for only 90 days or less, buyers are locked into a very narrow 
period to purchase, transport and discharge their cargoes before 
expiration of the permit.
    While the technical requirement imposed on importers is to obtain 
an import permit in advance of contracting for commodity shipments, the 
current AQSIQ requirement is essentially unworkable, as importers buy 
products when prices are low--sometimes months ahead of actual 
shipment. Contracting parties cannot wait to obtain an import permit 
first, before making a contract for shipment of commodities.
    Although China removed soybean import quota control in 1999, the 
Chinese government now appears to control import volume through WTO-
inconsistent methods such as the use of quarantine import permits.
    In the recent past, AQSIQ has slowed the issuance of permits, which 
has resulted in significant commercial uncertainty and, in some cases, 
has placed U.S. foreign investment in the Chinese agricultural sector 
at risk. Because of the commercial necessity to contract for commodity 
shipments when prices are low, combined with the inherent delays in 
having import permits issued, many cargoes of soybeans end up arriving 
in Chinese ports without import permits. This has created delays in 
vessel discharge and resulted in demurrage bills for Chinese buyers.
    AQSIQ has committed to notify importers about the result of their 
permit application within 30 days of receipt. However, some importers 
are waiting well beyond 30 days without obtaining any feedback from 
AQSIQ, as provincial CIQ offices that act as intake centers for import 
permit applications appear to be asked to delay submitting these 
applications to AQSIQ in Beijing. This effectively extends the 30-day 
notice period AQSIQ has to respond to the party requesting an import 
permit.
    Most recently, AQSIQ has suggested to foreign diplomats that it 
will take action to restrict specific firms from exporting or importing 
soybeans based on allegations that the firms have failed to meet 
certain quarantine regulation and mandatory quality requirements. The 
quality requirements and quarantine regulations are undocumented, non-
transparent and do not comply with the requirement of the WTO SPS 
Agreement or the International Plant Protection Convention.
    Recommendations:

 AQSIQ should restrict its activities to science-based, WTO and 
    international convention compliant import quarantine procedures and 
    should not impose delays, uncertainties, commercially 
    discriminatory or commercially unrealistic requirements that 
    inhibit free trade.
 AQSIQ should approach the approval of import permit requests 
    in a timely and commercially realistic manner.
 AQSIQ should ensure that all formalities are transparent, with 
    clear timelines openly promulgated.

                     AGRICULTURAL EXPORT SUBSIDIES

    U.S. feed grain producers and exporters have serious concerns about 
China's failure to live up to the commitment to eliminate export 
subsidies for corn.
    We are convinced China is using export subsidies to ship major 
volumes of corn into markets such as South Korea, Malaysia, Indonesia 
and most recently Japan. After a record-setting year in 2002, exporting 
more than 11.6 million tons of corn, China is currently 100 percent 
above that year's pace in exporting 6.7 million metric tons in the 
first 6 months of 2003 (1.8 million metric tons in June alone). Those 
exports have come mostly at the expense of the U.S. corn industry. If 
China's use of export subsidies for corn is not addressed now, we will 
continue to see significant erosion of U.S. markets throughout Asia.
    Prior to its WTO entry, China subsidized corn exports at $40-$45 
per ton. However, throughout much of 2002 and 2003, the price for 
Chinese corn exports has 
remained at pre-accession levels. Given China's ocean freight and 
internal corn costs, it is inexplicable how corn could be exported at 
those prices without further government subsidization, even after 
accounting for measures outlined by the Chinese government to reduce 
corn export prices. By calculating the size of the gap between domestic 
and export prices, the findings refute explanations given by Chinese 
officials as to how China was able to reduce corn export prices after 
WTO accession by means allowable under WTO rules, i.e., VAT rebate and 
transportation tax waivers.
    Recently, world prices have increased while China's domestic corn 
prices have decreased, reducing the need for export subsidies. However, 
we still question how China is exporting at levels of $15 to $25 per 
ton below domestic prices. We are also concerned that the VAT is not 
being collected on domestic corn, or is being assessed at a much lower 
rate than the officially declared 13 percent. Furthermore, with China's 
grain stocks currently at a very high level, there will be additional 
pressure for China to continue to aggressively subsidize corn exports 
throughout next year if allowed to do so. China has exported more than 
18 million metric tons of corn at price levels significantly below 
domestic prices during the past year. 
Although China has announced measures to lower the corn price for 
export within WTO disciplines, it is clear that corn exports continue 
to be subsidized by the 
government.
    Although the subsidy gap between China's domestic and export prices 
for corn has narrowed in 2003, it still accounts for a substantial 
competitive advantage for China as its exports remain at record high 
levels. Based on data provided by the U.S. Grains Council, Chinese 
exports to South Korea in June were priced at $106 FOB China (Dalian). 
Mid-June domestic corn prices at Dalian were 1060 RMB/mt or $128/mt. On 
a direct comparison basis, the gap between domestic and export prices 
would then stand at $22/mt for June. Using a 6-month lag from the time 
contracts were signed and shipments exported--so that the June export 
price is compared to December 2002 domestic price (1030 RMB, or 
$124.50)--the gap amounts to about $18.50 (about 15 percent of the 
domestic FOB Dalian price).
    While export prices for the July September period may be slightly 
higher than June's $106/mt, they most likely will not be more than 
$110/mt (current domestic Dalian prices are unchanged at $128/mt). That 
implies a significant gap continuing in the foreseeable future. If 
China continues to apply these levels of subsidies to corn exports the 
remainder of this year, U.S. exports will be significantly impaired in 
this current marketing year.
    Recommendations:

 China should formally and fully account for the discrepancy in 
    domestic and export corn prices.
 China should immediately meet its WTO commitment and proceed 
    to eliminate the officially supported mechanisms that permit 
    exports at lower than domestic prices.

                    AGRICULTURAL TARIFF RATE QUOTAS

    China has not made sufficient progress\1\ in implementing tariff 
rate quotas (TRQs) for bulk agricultural commodities such as wheat, 
corn, cotton and vegetable oil in a manner that opens the market to 
trade as anticipated under China's WTO accession agreement. Regulations 
designed to establish TRQ systems were late in being released, lack 
sufficient transparency and introduce unreasonable licensing procedures 
for importers. In some cases, China has contravened its accession 
agreement by allowing TRQs reserved for ``non-state trading companies'' 
to be issued to state-owned enterprises.
---------------------------------------------------------------------------
    \1\ It should be noted that China's Ministry of Commerce and 
National Development and Reform Commission has recently published a 
draft regulation amending management of TRQs for imported agricultural 
products. The impact of the new regulation needs further review.
---------------------------------------------------------------------------
    The TRQs for corn and wheat in many cases were distributed in such 
small quantities as to render them uneconomic to fulfill. When TRQs 
were issued, it has been very difficult, if not impossible, to 
ascertain which companies were granted quotas. This is in violation of 
the WTO agreement.
    Of greatest concern is that the State Development and Reform 
Commission (SDRC) requires a significant portion of each TRQ be used 
only for processing and mandatory re-export of finished products. This 
restriction is most important for cotton, where well over one half of 
the TRQ is restricted to re-exports and represents a violation of 
China's accession agreement.
    Recommendations:

 China should honor its TRQ obligations and not engage in such 
    practices as: delaying announcements; granting insignificant, 
    uneconomic quotas; applying restrictions that are not required of 
    domestic producers or merchants; or designing non-tariff trade 
    barriers that circumvent TRQ obligations.
 China should ensure that there is greater transparency in the 
    TRQ process, including the requirement to publish a list of 
    importers that have been granted TRQ allocations.
 China should eliminate the quota for mandatory re-export 
    provisions.

    In summary, much has been accomplished with regard to Chinese 
accession to the WTO and the commitments related to agricultural trade. 
However Chinese commitments and U.S. expectations are for additional 
and more timely progress. The United States and Chinese government have 
demonstrated an ability to resolve some outstanding issues. Given the 
importance of several unresolved concerns to both China, the U.S. and 
global markets, renewed commitment and additional effort by the United 
States, China, and the WTO are warranted.
    Thank You
                                 ______
                                 

                    Prepared Statement of Brad Smith

                           SEPTEMBER 24, 2003

                                OVERVIEW

    Thank you, Mr. Chairman and Commission Members, for the opportunity 
to testify. If it is acceptable, I would like to have my written 
testimony, which expands on my oral comments, added to the record.
    The U.S. insurance industry strongly supported permanent normal 
trade relations (PNTR) for China because the Chinese accession package 
was extremely broad and deep, and when fully implemented holds the 
promise of opening the vast Chinese insurance market to U.S. insurance 
and retirement security providers. We were aware from the outset that 
no agreement is self-implementing, and that the key to realizing 
successful profit from Chinese accession to the WTO is an efficient and 
transparent implementation process.
    With the ongoing leadership and support of the U.S. Government 
trade negotiators and facilitators, ACLI and our property casualty 
counterparts at the American Insurance Association have established 
what we consider to be a positive implementation dialog with the 
Chinese Insurance Regulatory Commission (CIRC), which has already led 
to a much improved communications and transparency process for U.S. 
insurers in China.
    Based on draft regulations just released by CIRC, we are cautiously 
optimistic that our primary concern to date (unjustifiably high 
capitalization requirements) has largely been addressed. As the next 
step, we have submitted a detailed list of additional questions to 
which we are seeking clarification from CIRC. We are optimistic that 
the United States Trade Representative (USTR) will be able to schedule 
a meeting to review this agenda by the end of the year.

                               BACKGROUND

    China's formal membership in the World Trade Organization offers 
great promise and opportunity for life insurers. The ACLI and the 
broader U.S. insurance industry, especially our property casualty 
counterpart--the American Insurance Association, were strong supporters 
of Permanent Normal Trade Relations (PNTR) for China because the 
insurance liberalization commitments contained in China's schedule of 
specific commitments and ``Working Party Report'' were broad and deep, 
holding the promise of opening the Chinese market to U.S. insurance 
companies and pension providers. Through experience with bilateral 
insurance agreements in Japan and South Korea, we knew at the time of 
China's accession that no agreement is self-implementing, and that the 
most important part of the opening of the Chinese insurance market 
would be in the implementation phase.
    With China now in the WTO, through the good offices of the U.S. 
Trade Representative, the U.S. Commerce, State and Treasury 
Departments, and through the communications of many interested Members 
of Congress, we (ACLI and AIA) have begun the process of establishing a 
dialog with the Chinese Insurance Regulatory Commission (CIRC) about 
the implementation of their liberalization commitments. Establishment 
of regular, straightforward two-way communication is, in our opinion, 
the best way to avoid possible misunderstandings, frustrations or 
disappointment about China's liberalization process.
    The task before CIRC is substantial, as it is in everyone's 
interest that the Chinese insurance market not only be open but well 
run and prudentially sound. Our intent is therefore to make a positive 
contribution to this process, by providing CIRC and other Chinese 
decision makers our comments on their implementing regulations, and 
where appropriate, include technical research to help them in setting 
standards that meet the test of prudential justification.
    Individual company experience with CIRC varies greatly. Some 
describe relations as perfect and others describe them as frustrating, 
but our member companies support this constructive engagement approach 
for the same reasons many companies have funded representative offices 
all over China, some going back for more than 10 years. The Chinese 
market is seen to have tremendous potential, and many U.S. companies, 
like our international competition, see entry into China as key to a 
global strategy. Recent industry press headlines such as ``Chinese 
Insurance Premium Grew 33 percent For First 7 Months'' and ``China Will 
Be Second Largest Insurance Market by 2032, Says IBM,'' typify stories 
of the growth of the market since first being liberalized in 1992--we 
intend to be part of that.
    With regard to China's implementation of their WTO insurance 
commitments, while the process is moving forward, the lack of clarity 
in the regulatory process has slowed and confused the fulfillment of 
China's insurance liberalization obligations.
    Since joining the WTO in December of 2001, Chinese insurance 
regulators have promulgated five sets of regulations with the stated 
intention of implementing China's WTO insurance commitments. The first 
set went into effect in early February of 2002 and provided a general 
framework for the regulatory structure but offered little specificity 
regarding the implementation of their liberalization commitments. 
Procedures for branching, capitalization and solvency regulation and 
other fundamental processes by which U.S. Insurers could procure a 
license and begin operations were not included. US insurers provided an 
analysis of these regulations for USTR, pointing out the vagaries of 
the regulation as well as several specific regulatory articles that 
could be inconsistent with China's WTO obligations. USTR then met with 
Chinese regulators to communicate these questions and concerns and were 
told additional regulations would be forthcoming.
    Chinese regulators subsequently released a second set of 
regulations in late February 2002 to further clarify the licensing 
procedures. USTR again communicated directly with CIRC regarding 
questions and concerns, which still had not been clarified. CIRC 
informed USTR of further forthcoming regulations and stated that China 
would fully implement their WTO liberalization commitments.
    Concurrent with this informal bilateral dialog, USTR had requested 
answers to a detailed set of the same questions at the Transitional 
Review Mechanism discussion in the WTO Committee of Trade in Financial 
Services. This engagement has been continued at each subsequent CTFS 
meeting, with the same questions being echoed by the Governments of 
Canada, the European Union, Australia, South Korea and Switzerland.
    Based on both the formal requests in the CTFS and the informal 
bilateral dialog, in October of 2002, Ambassador John Huntsman 
requested a meeting with CIRC that would be open to a small number of 
U.S. and Chinese insurance industry representatives as well as USTR 
representatives. At the suggestion of USTR, it was decided to focus 
exclusively on the highest priority issue--capitalization levels 
required of an initial establishment of a foreign insurer, and 
subsequent capitalization required when additional branches would be 
opened.
    Our concerns were that the regulations were unclear because of 
conflicting overlap from multiple regulations, and because the amounts 
called for were well outside of prudentially justifiable international 
norms, thus creating a barrier to entry for many U.S. insurers. Our 
objective for the meeting was to seek clarification of the specific 
requirements, and to provide information on international benchmarks 
for prudentially justifiable capitalization levels. Thanks again to 
USTR, the U.S. Embassy in Beijing and the U.S. Commerce Department, on 
December 13, 2002 we participated in a meeting in Beijing with CIRC, 
Chinese industry representatives and a U.S. Government and industry 
delegation headed by Deputy Assistant USTR, Charles Freeman.
    Our presentation, attached for entry into the record, was entitled 
``A Recommendation for Revisions to the Capitalization Requirement 
Rules for Life Insurance Companies Operating in China,'' highlighted 
just how far outside international norms China's capitalization levels 
were, and presented a model that our consultant, Watson Wyatt Insurance 
Consulting Limited, felt might be more appropriate for the Chinese life 
insurance market. CIRC listened, agreed that our worst-case projection 
of the capitalization requirements was currently correct, stated that 
there were plans to revise the relevant regulations, and agreed to 
consider our views.
    Meanwhile, we discussed our capitalization concerns with other 
service industry groups in the U.S., Canada, Europe and Japan, fellow 
members of the ``Financial Leaders Group'' and found that our 
capitalization concerns were not unique. Service sectors such as 
banking, securities, auto finance and express delivery are facing 
similar problems. Thus, in February of 2003, the Financial Leaders 
Group delivered a letter to Chinese officials commenting on the 
prudentially unjustifiably high capitalization levels in many services 
sectors, including insurance, and the issue was again highlighted at 
the CTFS meetings in Geneva by the Quad Governments. CIRC subsequently 
stated that additional regulations to fulfill China's WTO 
liberalization commitments would be forthcoming.
    It should be noted that neither of the first two insurance 
regulations were publicly released in draft for public comment. The 
U.S. industry provided comments anyway: No formal response was 
received.
    On July 31, 2003 a third set of regulations (``The Draft Trial 
Implementing Rules on the Regulations of the PRC on the Administration 
of Foreign-Invested Insurance Companies'') were placed on the CIRC web 
site with a request for public comment by August 15. To our surprise, 
on August 18, 2003, another set of regulations (``Draft Administrative 
Regulations on Insurance Companies of the People's Republic of China'') 
was also posted to the CIRC web site requesting public comment by 
September 16. In both instances, we translated the draft regulations 
and circulated them widely within the U.S. insurance industry.
    In both instances we submitted formal written responses to CIRC 
within the requested timeframe. We commended them for their public 
outreach, and stated that their openness supports our firm belief that 
the most important factor contributing toward the successful 
development of the Chinese insurance sector will be the 
institutionalization of a regular and robust public dialog. We 
expressed our hope that this initiative can be expanded through 
increased communication and cooperation with interested international 
companies and industry associations, and committed ourselves to provide 
professional and timely responses to CIRC on an ongoing basis. We also 
stated that a dialog on these drafts and/or any revised drafts that 
CIRC circulates for additional comment would be an excellent basis for 
continuing the dialog we began last December in Beijing.
    The major notable development in these recent drafts is a 
significant lowering of the required capital for initial establishment 
and full national operations, which, if implemented, bring the 
capitalization requirements closer to the acceptable range of 
international comparables for some lines of business and business 
models. This is a major step forward for CIRC, which we feel supports 
the benefits of continued dialog. We plan to extend this dialog to now 
include our other priority areas of concern.
    Continuation of this dialog must be two-way. Many of our concerns 
involve confirmation of our understanding of the meaning of vague or 
conflicting regulations. So that this dialog is as clear as possible, 
we hope to receive written responses to our inquiries from CIRC. This 
has also been requested by USTR. We look forward to a meeting in 
Beijing to focus on this agenda by the end of the year, and greatly 
appreciate USTR's efforts to schedule it.
    Top priorities we would like to have included in the dialog agenda 
are (by category of type of issue):

                        FUNDAMENTAL ASSUMPTIONS

    We seek confirmation of the following fundamental assumptions, 
which are key to our understanding of the prudential intentions of the 
Chinese Insurance Regulatory System.

Fundamental Assumption--1
    That CIRC is undertaking, through measures to date and in the 
future, an approach consistent with the PRC's WTO obligations regarding 
market access, national treatment and transparency, and that the only 
discrimination (differences) between provisions for domestic and 
foreign insurance companies is where there is a clear and necessary 
prudential justification. Furthermore, that it is the goal of CIRC is 
to have one set of regulations and procedures for domestic and foreign 
companies, so that the regulations are consistent with China's WTO 
commitments.

Fundamental Assumption--2
    That there are three (3) documents/rules/regulations relevant to 
this exercise. They are (working back from the present): (A) the Draft 
Insurance Company Administrative Regulations (hereinafter the 
``Measures.''); (B) the Draft Trial Implementing Rules on the 
Regulations of the PRC on the Administration of Foreign-Invested 
Insurance Companies, July 31, 2003 (hereinafter ``Implementing 
Rules''); and (C) The Administrative Regulations on Foreign-Invested 
Insurance Companies of the PRC, Feb. 2002 (hereinafter the 
``Administrative Regulations'').

Fundamental Assumption--3
    That the three documents are each intended to accomplish a specific 
regulatory function and that there is no intentional overlap or 
conflict between the provisions of the three documents, especially with 
regard to the application of measures as between domestic and foreign 
companies.

Fundamental Assumption--4
    That only the ``Implementing Rules;'' and the ``Administrative 
Regulations'' are applicable specifically to foreign companies.

Fundamental Assumption--5
    That the ``Measures'' are relevant to all companies both domestic 
and foreign equally without discriminatory interpretation.

                          IMPLEMENTATION GAPS

    We would like written responses to three questions regarding gaps 
in the regulations where they should reference major elements of the 
implementation of China's WTO liberalization commitments:

Implementation Gap--1
    It should be noted in the ``Implementing Rules'' that several 
existing joint venture companies have foreign registered capital 
interests that are above 50 percent. It should be confirmed that these 
companies, and any subsequent foreign companies approved by CIRC to own 
more that 50 percent, are grandfathered in accordance with China's WTO 
commitments, and that such companies will be allowed to expand 
geographically (through branches and sub-branches) in their current 
ownership structure.

Implementation Gap--2
    Prior to China's WTO accession, a number of foreign insurance 
companies were allowed to establish operations in the PRC. All of these 
companies were requested by the Chinese Government to incorporate as 
operational branches, not as subsidiaries.
    However, in both of the two new sets of draft regulations (the 
``Administrative Regulations,'' and the ``Implementing Rules''), there 
does not appear to be any article that addresses the maintenance and 
development of these branch operations. We believe a section should be 
added explaining the administrative procedures under which a 
``guaranteed branch/sub-branch structure'' should be allowed to 
operate. (By ``guaranteed branch/sub-branch structure'' we mean 
branches and sub-branches whose solvency is guaranteed and supported by 
the total assets of the parent company.) The branch/sub-branch 
structure is a well-established international norm appropriate for 
application in China. Accordingly, regulations should be developed to 
govern those branches already established in China and such future 
branches that may be established in China. We recommend that these 
regulations conform to the internationally accepted branch/sub-branch 
operating structure.
    Indeed, in most countries and in accordance with international 
norms, when insurance companies enter foreign markets, they are allowed 
to establish an initial branch or home office and then expand to new 
locations throughout the country through a network of sub-branches. 
These sub-branches report to the original branch or home office.
    This branch/sub-branch structure is supported by, and legally tied 
back to, its corporate parent. Thus, branch operations should not be 
treated as if they were separate, stand-alone entities. Likewise, because 
a branch/sub-branch structure is supported by its parent corporation's 
assets, the company should not have to recapitalize when expanding to a 
new location. This branch/sub-branch operating structure is an established international norm and a widely accepted principle of operation.
    For property casualty insurance companies the ability to expand by 
sub-branch is particularly important. Foreign insurance companies 
should be allowed to expand geographically in the Chinese insurance 
market in accordance with established international norms and operating 
practices (i.e., through the use of the internationally accepted 
branch/sub-branch structure). Specifically, foreign insurance companies 
should be able to establish a branch (with a reasonable initial 
capitalization) backed up by the strength of the parent organization, 
and be allowed to expand throughout the country--in accordance with 
China's timetable for the phase-out of geographical restrictions--
through the establishment of sub-branches. The establishment of sub-
branches should not be limited to the immediate, licensed region or 
territory. Also, the company should not have to separately capitalize 
each new location.
    We also request clarification with respect to branch boundaries. We 
believe that it is more efficient to establish provincial-level 
branches rather than only municipal-level branches. Domestic companies 
are able to operate at the provincial level with access to all cities 
and localities in the province. To date foreign companies have received 
approval to operate at only in one specific city. Foreign companies 
like their domestic counterparts should have provincial level licenses.
    The proposed rules are also silent as to their impact on existing 
insurance company operations, including existing branches. It is, 
therefore, assumed that branches and other insurance company operations 
that exist today may, but are not required to, continue to operate 
under the conditions and approvals that existed prior to this rule, 
including but not limited to operations, financial structure, capital 
and mode of establishment. This understanding should be confirmed.
Implementation Gap--3
    In addition to its insurance and reinsurance liberalization 
commitments, China committed to liberalize its pension market within 5 
years of joining the WTO. To date, no regulations or laws have been 
released in anticipation of the opening of this important market 
sector. CIRC or other relevant authorities, should begin a public 
comment process well in advance of the approaching phase in deadline to 
gain the broadest level of comment and support for this fundamental 
undertaking.

                      NATIONAL TREATMENT QUESTIONS

    In addition to the questions on fundamental assumptions and the 
further information needed to fill the implementation gaps, we would 
also like to receive confirmations from CIRC on the following specific 
questions regarding national treatment.

National Treatment Question--1
    RE: Article 3 on the August 18th Draft of Administrative 
Regulations on Insurance Companies of the People's Republic of China. 
If we understand this correctly we interpret it to say that with 
respect to branch boundaries for foreign invested insurance companies, 
that they are treated the same as domestic companies which we 
understand are defined at the provincial-level (On May 21, CIRC 
approved Min Sheng Life to prepare 4 branches in Beijing, Nanjing, 
Hangzhou, and Shijiazhuang. (Source: China Insurance News, June 2003) 
If this is a correct understanding we believe that it is more 
efficient, and is a major step forward for CIRC in fulfilling their 
mission to implement China's WTO national treatment obligations. 
Domestic companies are able to operate at the provincial level with 
access to all cities and localities in the province. To date foreign 
companies have received approval to operate at only in one specific 
city. Foreign companies like their domestic counterparts should have 
provincial level licenses.

National Treatment Question--2
    RE: Article 11 on the August 18th Draft of Administrative 
Regulations on Insurance Companies of the People's Republic of China. 
If we understand this correctly, we interpret it to say that with 
respect to branch applications for foreign invested insurance 
companies, that they are treated the same as domestic companies which 
we understand can apply for any number of branch approvals 
simultaneously with no limit to the number of branches a company may be 
granted at any given time.

National Treatment Question--3
    RE: Article 13 of the August 18th Draft of Administrative 
Regulations on Insurance Companies of the People's Republic of China. 
As there is no reference to any waiting period, we request confirmation 
in this article that no waiting period exists before licensed insurance 
companies, domestic or foreign, can apply for branch or sub-branch 
licenses.

National Treatment Question--4
    RE: Article 99 of the August 18th Draft of Administrative 
Regulations on Insurance Companies of the People's Republic of China. 
As it is so vague, we are concerned that Article 99 could be used to 
justify discrimination against foreign insurers, contrary to China's 
WTO commitments on national treatment. Accordingly, we would urge 
confirmation that the scope of Article 99 is limited solely to matters 
where the prudential justification will be clearly explained and 
limited to as least discriminatory as possible.

                       PRUDENTIAL JUSTIFICATIONS

    In addition to the questions on fundamental assumptions, the 
further information needed to fill the implementation gaps, and 
questions of national treatment we would also like to receive responses 
from CIRC on the following questions of prudential justification.

Prudential Justification--1
    RE: Article 6 (b) of the August 18th Draft of Administrative 
Regulations on Insurance Companies of the People's Republic of China. 
We would like to understand the prudential reasoning behind the 
capitalization requirements. We believe that RMB200 million is too 
prescriptive in nature and may be much higher than international norms 
with respect to specific business models and risks being assumed. We 
feel that CIRC should be granted the discretion to lower this amount 
where it feels appropriate. Also, we request clarification of the scope 
of the initial establishment of RMB 200 million. Please confirm that 
this includes the right to establish sub-branches without limitation as 
to numbers.

Prudential Justification--2
    RE: Article 12 of the August 18th Draft of Administrative 
Regulations on Insurance Companies of the People's Republic of China. 
We would like to understand the prudential reasoning behind the 
branching capitalization requirements of RMB20 million for each 
additional branch. We feel this is duplicative, contrary to China's WTO 
commitments, and has no prudential justification. Additionally we feel 
it is an inefficient use of capital, which will raise the cost of 
products to Chinese consumers.
    In summary, it is vitally important that all parties work together 
in a clear and open manner to ensure understanding of CIRC's 
implementation process. Any measures China implements that give the 
impression of falling short of its WTO commitments and denying U.S. 
insurance companies meaningful market access in China could create 
hostility. Thus, it is in the interests of CIRC to continue a 
meaningful two-way dialog to make the implementation of China's WTO 
insurance commitments as smooth and positive as possible.
    ACLI and our industry colleagues appreciate the hard work and high-
level leadership of USTR and the other relevant U.S. Government 
agencies that have helped establish and grow this dialog with China. 
Likewise, the industry greatly appreciates the ongoing support of 
Members of Congress. We consider ourselves still at the beginning of a 
complex process, and will look forward to an ongoing relationship with 
your Commission as we proceed through the years to come. While we do 
not know when China's draft regulations will enter into force, it is 
our hope that our dialog, with your and the government's assistance, 
will produce a transparent and effective body of regulations comporting 
with China's strong and admirable WTO commitments. We will report to 
you as circumstances develop.
    Thank you for your interest and consideration in this matter. I 
would be pleased to answer any questions that you may have.



































































































































                   Prepared Statement of Daryl Hatano

                           SEPTEMBER 24, 2003

    Chairman Leach, Chairman Hagel, distinguished Commission members, 
the Semiconductor Industry Association (SIA) is pleased to testify 
today regarding China's compliance with its WTO commitments. The SIA 
represents the $70 billion U.S. semiconductor industry. U.S. 
semiconductor firms are leading global competitors, commanding 50 
percent of world market share.
    China represents a large and growing market for semiconductors and 
other information technology products. In fact, semiconductors are the 
second largest U.S. 
export to China. Over the past decade, SIA was a strong supporter of 
legislation to provide Permanent Normal Trade Relations with China as 
part of China's entry into the WTO, and SIA is pleased that the Chinese 
government has taken a number of positive steps in implementing its WTO 
obligations. However, several areas will require continued efforts by 
the Chinese government in order to fulfill the commitments made under 
WTO accession. My comments today will only elaborate on those issues of 
special relevance to American semiconductor producers, including 
China's value added tax rebates for domestically produced chips, 
semiconductor intellectual property, transparency, and local content.

                              CHINA MARKET

    In 2001 the Asia Pacific region, driven primarily by growth in 
China, surpassed the U.S. as the largest semiconductor market in the 
world. In terms of demand, in 1997, the U.S. represented 33 percent of 
the world market, while the Asia Pacific region represented 22 percent. 
Five years later, in 2002, the Asia Pacific share had grown to 36 
percent, compared to the U.S. share of 22 percent--a reversal of 
positions. By 2005, the U.S. is projected to be the smallest of the 
four regional markets,\1\ representing only 18 percent of the world, 
less than half of the 40 percent share that the Asia Pacific market is 
projected to represent. The growth of the Asia Pacific market has been 
driven by the growth in China. China's $18 billion integrated circuit 
market represented 15 percent of total world demand in 2002, up from 7 
percent of the world in 2000.
---------------------------------------------------------------------------
    \1\ The four regions are North America (primarily the United 
States), Europe, Japan, and Asia Pacific.
---------------------------------------------------------------------------
    China's semiconductor market growth is occurring within the context 
of significant growth in China's computer and telecommunications 
markets. China is now the world's largest mobile phone market, and 
second largest personal computer market.
    Currently domestic Chinese production, including foreign owned 
facilities in China, meets only about 15 to 20 percent of its market 
demand, with the remaining 80 to 85 percent met by imports. The Chinese 
government's Tenth Five Year Plan, covering 2001-2005, has an ambitious 
target to ensure that by 2005 ``60 percent of IT products should be 
home grown,'' and that China shall ``gradually design and 
develop its own IC products, (including [central processing units]).''

                         SIA'S EFFORTS IN CHINA

    SIA has been encouraging an open trade environment in China for 
over a decade. SIA has sent delegations to China since the early 1990s 
to meet directly with Chinese government and industry officials to 
discuss the benefits of market liberalization to China's economic 
growth and to U.S.-China relations. SIA provided advice to the U.S. 
Government on the WTO accession issues of importance to the 
semiconductor industry and, as noted earlier, was an active supporter 
of legislation to allow Permanent Normal Trade Relations with China.
    Based on SIA's interactions with senior Chinese government 
officials, we believe that there is a genuine commitment expressed by 
all Chinese officials to full and faithful execution of China's WTO 
obligations.
    SIA was pleased that China became a signatory of the WTO's 
Information Technology Agreement (ITA) in April 2003, committing to 
eliminate tariffs on a range of information technology products. SIA 
has long supported the elimination of semiconductor tariffs, beginning 
with the suspension of U.S. tariffs in 1985, because tariffs increase 
costs to consumers and thus impede the ability of consumers to take 
advantage of semiconductor technology. SIA was an early supporter of 
the ITA, and China's joining this agreement was a high priority because 
of the consumer benefits that would flow from the elimination of 
tariffs on semiconductors, computers, telecommunications equipment, and 
semiconductor manufacturing equipment. The elimination of China's 6 to 
12 percent semiconductor tariffs in January 2002, contributed to a 
reduction in smuggling and resulting shift to legitimate import 
channels, better positioning U.S. companies to take advantage of 
trading rights when they are fully phased in at the end of 2004 (3 
years after accession). SIA was pleased that China was able to resolve 
the ``end use'' certification issue that had initially prevented its 
formal participation in the ITA. China had imposed ``end use'' 
certification requirements on 15 ITA products, that were inconsistent 
with the ITA, and would have created a dangerous precedent, especially 
as we sought to expand the ITA to additional countries. SIA is pleased 
that China is now a full participant in the ITA, and we appreciate the 
efforts of USTR that led to this result.

                            VALUE-ADDED TAX

    China imposes a value-added tax (VAT) of 17 percent on sales of all 
imported and domestically produced semiconductors and integrated 
circuits. However, current Chinese government policy provides for a 
rebate of the amount of the VAT burden in excess of 6 percent for 
integrated circuits manufactured within China (and the amount of the 
VAT burden in excess of 3 percent for integrated circuit designs 
developed in China).\2\ This discrimination against imported 
semiconductors through the VAT rebate is inconsistent with China's WTO 
obligations.
---------------------------------------------------------------------------
    \2\ State Council Document Number 18, June 2000.
---------------------------------------------------------------------------
    Reduction of the semiconductor VAT should apply to all 
semiconductors and integrated circuits sold in China (whether 
domestically produced or imported). Application of the VAT reduction to 
all companies would allow China to come into compliance with its WTO 
obligations to refrain from discrimination against imports while 
maintaining its commitments to investors in domestic facilities of a 
reduced VAT rate.
    GATT Article III (on ``National Treatment'') establishes a general 
prohibition against a WTO member engaging in activity that 
discriminates in favor of domestic products at the expense of imported 
products. Specifically, paragraph 2 of this article states that a WTO 
member cannot impose taxes on imported products that are greater than 
those imposed on domestic products. By rebating the amount of the VAT 
burden over 3 percent or 6 percent for local products, while continuing 
to impose the full 17 percent VAT on imported semiconductors, the 
current policy violates this basic GATT/WTO obligation.
    Prior GATT decisions clearly establish that it is a violation of 
the national treatment principle to grant a tax credit or rebate to 
certain domestic manufacturers of a product while charging the full tax 
rate to similar foreign-manufactured products. This is true even if the 
tax credit or rebate is intended to provide a subsidy to local 
producers. While China does provide the benefits to both domestic and 
foreign-owned facilities in China, the different treatment of domestic 
and imported products is a violation of its national treatment 
commitment. Any tax imposed on imported goods must be collected in a 
non-discriminatory manner.
    The best solution for U.S. export interests and the development of 
China's information technology market is for the PRC to reduce or 
eliminate the VAT rate for all semiconductors and integrated circuits, 
regardless of origin.
    As noted above, China joined the Information Technology Agreement 
(ITA) and has eliminated all tariffs on semiconductors in 2002 and will 
eliminate tariffs on other information technology products in the near 
future. The same public policy reasons that caused China to decide to 
eliminate its tariffs on semiconductors apply with equal force to a 
decision to lower the VAT rate. A substantial portion of the growth of 
the American economy has been attributed to information technology and 
the productivity enhancements made possible by advances in 
semiconductor technology and production. Just as it was in China's 
interest to eliminate all import 
tariffs on semiconductors, significant reduction in the VAT rate 
imposed on all semiconductors would contribute to the growth of the 
Chinese IT market and would 
benefit the Chinese economy in general. In addition, reports indicate 
that China's elimination of semiconductor tariffs (formerly 6-12 
percent) has succeeded in reducing smuggling of semiconductors into 
China. As the high VAT rate on semiconductors provides an incentive for 
smuggling, this runs counter to the high priority the Chinese 
government has placed on eliminating illegal entry of goods.
    Although it is not designed to do so, the high VAT rate imposed on 
semiconductors imposes significant costs on Chinese electronics 
producers on exports from China. While China ostensibly rebates the VAT 
on semiconductors and other electronics components when the finished 
product containing the inputs is exported, many exporters from China 
have been unable to receive the full amount of the rebate officially 
due to them because provincial and local authorities may refuse to 
rebate VAT charges collected by another jurisdiction within China.
    There have been several noteworthy developments on the VAT rebate 
issue this year. First, there is the growing recognition in Washington 
as well as in other world capitals that China's VAT rebate program is a 
violation of the WTO. In March, 32 Members of the U.S. House of 
Representatives sent a letter to Ambassador Zoellick stating ``We 
believe China should eliminate the VAT for all semiconductors 
regardless of origin and we encourage you to continue to press for a 
speedy resolution of this violation.'' In June, 21 U.S. Senators sent 
Ambassador Zoellick a letter stating ``We urge you to continue to 
vigorously insist that China lower its VAT on semiconductor imports to 
abide by its World Trade Organization (WTO) commitments . . .'' Many of 
you on the Commission signed these letters, and we appreciate the 
continued support of Congress on this issue.
    In May, the World Semiconductor Council (WSC) issued a joint 
statement critical of China's VAT rebate program. The WSC is composed 
of CEOs from companies representing the European Semiconductor Industry 
Association (EECA-ESIA), Japan Electronics and Information Technology 
Industries Association (JEITA), Korea Semiconductor Industry 
Association (KSIA), Semiconductor Industry Association (SIA), and 
Taiwan Semiconductor Industry Association (TSIA). The WSC stated:

          ``. . . under China's current application of its Value Added 
        Tax (VAT), a VAT of 17 percent is applied to all 
        semiconductors, but companies designing and manufacturing 
        semiconductors in China are eligible to receive a substantial 
        rebate of the VAT paid on those semiconductors. This reduces 
        the effective VAT burden on domestically designed and produced 
        semiconductors to only 3 percent. Discrimination has the effect 
        of limiting market access, distorting patterns of trade and 
        investment, and negates the benefits China promised to provide 
        when it joined the WTO. The WSC calls for China to lower its 
        VAT rate to 3 percent for all semiconductors, regardless of 
        origin.''

    A second key development is USTR's formal inquiries to the Chinese 
on this subject. Coupled with the interest on Capitol Hill and the WSC, 
USTR's request that China address the VAT rebate problem has attracted 
the attention of Chinese government officials. As a result of this 
attention, China has formed a research group to re-examine the VAT 
issue. In SIA's recent meetings in China, we sensed a willingness in 
some quarters to explore alternatives with the U.S., but in other 
quarters, continued skepticism that changes were necessary. The U.S. 
government must continue to insist that China quickly come into 
compliance with GATT article III.
    Lowering the VAT for both domestically produced and imported 
semiconductors would be a non-discriminatory policy that is in China's 
interest for all the reasons set forth above. Non-discriminatory 
application of the VAT rebate for all semiconductors would allow 
Chinese electronics producers to obtain the most advanced technology 
available worldwide at the most competitive prices, benefiting Chinese 
consumers and the entire Chinese economy, as well as encouraging growth 
in China's IT sector.

                    INTELLECTUAL PROPERTY PROTECTION

    SIA would like to underscore the importance of China's full 
compliance with its commitments to improve intellectual property (IP) 
protection. This is critical not only to U.S. firms doing business in 
China, but also in China's self interest, as it will encourage the high 
technology foreign investment China seeks in order to promote the 
development of its economy while simultaneously encouraging local 
entrepreneurs to engage in innovation.
    Before discussing the issue of enforcement, let me begin by 
congratulating China for its success in resolving one issue related to 
its semiconductor layout design protection law. In March 2001, China's 
State Council passed Regulation on Integrated Circuit Layout Design 
Protection, which took effect October 1, 2001. Last year, a senior 
official of the Ministry of Information Industry made comments 
indicating that China's new law did not cover discrete semiconductors. 
SIA objected to this interpretation because the WTO TRIPs agreement is 
clear that discretes, which are products with only one active element, 
are to be protected. We are pleased to report that, in a response to a 
question posed by the United States, China affirmed before the Council 
for Trade-Related Aspects of Intellectual Property Rights that ``With 
respect to discrete mentioned in the question in particular, if it 
complies with provisions of Article 2 and Article 4 of the Regulations 
on the Protection of Layout Designs of Integrated Circuits, it can be 
protected through applying for registration of layout-design.'' \3\ We 
believe that this resolves the discretes issue, and again express our 
appreciation the USTR and Chinese government for their efforts to bring 
this question to a satisfactory conclusion.
---------------------------------------------------------------------------
    \3\ Council for Trade-Related Aspects of Intellectual Property 
Rights; Responses from China to the Questions posed by Australia, the 
European Communities and their member States, Japan and the United 
States; IP/C/W/374 10 September 2002; Page 43.
---------------------------------------------------------------------------
    SIA would like to highlight the need for strengthened IP 
enforcement. IP protection is important not only in China, but in all 
markets around the globe. The World Semiconductor Joint 2003 Statement, 
referenced above, emphasized the need for strong intellectual property 
protection around the world, stating:

          ``Semiconductor makers must invest a very high percentage of 
        sales in R&D, and the intellectual property that results is the 
        lifeblood of the company. Failure to adequately protect 
        intellectual property is very damaging to the semiconductor 
        industry. There are an increasing number of instances of 
        counterfeiting of IC's and other semiconductors. One form of 
        counterfeiting is the unauthorized direct optical copying of 
        the chip, and reproduction of a mask work (layout 
        design/topography) based on the optical copying, and then 
        fabrication of a semiconductor based on this mask work and sale 
        under a different company's name. Another form of 
        counterfeiting involves reverse engineering a company's chip, 
        and then producing a physically identical chip and selling it 
        without authorization under the original company's name and 
        trademark. Both types of counterfeiting must be quickly 
        addressed and stopped.''

    The World Semiconductor Council is now working on a proposal to 
establish fast track consultative mechanisms to encourage enforcement 
actions to counter IP violations, and to encourage manufacturers to 
develop policies to prevent their inadvertently making semiconductors 
that violate a third party's IP. We are hopeful that this proposal will 
be adopted in all semiconductor producing regions around the world.
    SIA is aware of numerous reports of IP violations in China. In one 
typical case, an SIA member company found that Chinese firms were 
making identical copies of its chips and data sheets, and selling it 
under the Chinese company's name. Under TRIPs, reverse engineering a 
chip to design an original and better product is allowed under the 
layout design laws. However in this case the chips were essentially 
photocopies of the U.S. design, which we know because the pirate 
included the U.S. company's part number etched in a submask level and 
unused circuits that the U.S. firm had placed on the chip to reserve 
space for future product development. The Chinese firms that engage in 
piracy are typically thinly capitalized companies that contract the 
manufacture of the copied chips to foundries that can afford to make 
the necessary capital expenditures.
    China's court system is still developing, and U.S. firms are 
concerned about the fairness of its procedures. For example, we 
understand that only ``legitimate'' purchases are actionable. These 
rules put an unreasonable burden on U.S. firms who cannot hire a 
private investigator to purchase the counterfeits, but must instead 
find purchasers of the counterfeit product and convince those purchases 
to sign a statement that they bought the counterfeit goods. China also 
has administrative enforcement mechanisms, but these are largely 
untested.
    In the aforementioned letter signed by 32 House members, the 
Representatives stressed that ``the improved laws China put in place to 
protect IP are useless unless they are supported by transparent, 
standardized and predictable court procedures that make the judicial 
system accessible . . . We must continue to demand that China 
immediately upgrade its IP enforcement mechanisms so that foreign 
semiconductor companies have certainty their products are protected in 
this emerging market.'' The letter signed by 21 Senators to Ambassador 
Zoellick stated ``We encourage you to continue to press for 
strengthened enforcement to bolster the credibility of [the IP] laws, 
and to explore with your Chinese counterparts alternative solutions 
such as fast track investigations of alleged piracy.'' Given its 
importance to both U.S. producers and China's economic development, SIA 
urges USTR and the Chinese government to continue to make IP 
enforcement a high priority issue.

                              TRANSPARENCY

    Several commitments in the final protocol of accession are expected 
to improve transparency in China's administrative rulemaking. For 
example, China has agreed that only those trade-related measures that 
are published and readily available will be enforced. China has also 
agreed to make information on trade-related measures available to WTO 
members upon request before those measures are implemented or enforced.
    Additionally, China has committed to establish or designate an 
official journal for the publication of all trade-related measures and 
to provide a reasonable period of time for comment to the appropriate 
authorities before measures are implemented. China is considering 
providing this information in English in order to provide transparency 
to the international business community, and to post the information on 
the web. These are important steps in improving transparency. SIA urges 
China to fully implement these measures.

                              LOCALIZATION

    There had been localization requirements for parts and materials 
for products made in China which, while not technically legal 
requirements, imposed serious restrictions on firms' ability to utilize 
imported parts. Firms had been required to file localization plans with 
their foreign investment application. The Chinese government also 
audited foreign firms to determine local content. What constitutes 
local content can be subject to many definitions. For example, 
importation via a Chinese distributor can qualify a part as ``local.'' 
Chinese sectoral industrial policies also contain local content 
requirements. Prior to its accession to the WTO, China had imposed 
local content requirements on products containing semiconductors.
    In our discussions with Chinese officials, there was a recognition 
that these policies are inconsistent with China's WTO obligations and 
would be repealed in time. SIA again calls for the immediate repeal of 
all local content policies as required by the terms of the WTO 
accession agreement.
    During the China WTO accession negotiations, the Chinese government 
confirmed that China would ensure that all state-owned and state-
invested enterprises would make purchases and sales solely on 
commercial considerations, e.g. price, quality, marketability, 
availability, and that the enterprises of other WTO members would have 
an adequate opportunity to compete for sales to these enterprises on a 
non-discriminatory basis. In addition, the Chinese government committed 
that it would not influence commercial decisions on the part of state-
owned or state-invested enterprises. Adherence to these commitments 
will be critical for China's development because it will ensure that 
Chinese electronics firms are able to purchase the most competitive 
chips free from political interference. Given the market access 
problems that the U.S. historically faced in other semiconductor 
markets, it is also critical to U.S. export interests that China's 
state-invested enterprises purchase solely on a commercial basis.

                               CONCLUSION

    China is a large and fast growing market. The economics of our 
industry dictate that U.S. firms, to remain competitive, must be able 
to compete on a fair and open basis for sales in China. For this 
reason, we are very encouraged by China's efforts to implement its WTO 
commitments, but we are concerned over the remaining existence of 
barriers and impediments to trade in China. While the challenge of 
promoting economic development in a country the size of China is 
immense, we are 
encouraged by China's progress and are hopeful that China will lower 
its VAT for all semiconductors, vigorously enforce its IP laws, 
eliminate its local content requirements, and improve transparency.
    SIA thanks the Commission for the opportunity to testify today. We 
look forward to continuing to work with the U.S. Government on these 
important issues.
                                 ______
                                 

                 Prepared Statement of William Primosch

                           SEPTEMBER 24, 2003

    Mr. Chairman and Members of the Congressional-Executive Commission, 
Thank you for giving the National Association of Manufacturers (the 
NAM) to testify on a subject of great interest to U.S. manufacturers.
    The NAM represents 14,000 manufacturing companies, both large 
multinational corporations and over 10,000 small and medium-size firms. 
I can tell that we hear more from our members about trade with China 
than with any other foreign country.
    Trade with China is of immense importance for U.S. manufacturers 
both because China's growing economy of 1.2 billion consumers offers a 
major market for U.S. products and because China is also an 
increasingly vigorous competitor in the U.S. and global marketplace.
    The Chinese market is set to become one of the largest in the world 
within the next several years. Chinese imports are expected to exceed 
$380 billion in 2003, making China the world's third largest importer 
after the United States and Germany. At the same time, China is rapidly 
becoming a major exporter of industrial goods, and the range of 
industrial products exported has continued to grow at a rapid pace. 
China's expanded participation in the global marketplace, then, offers 
both new commercial opportunities as well as challenges resulting from 
increased competition in the U.S. and foreign markets.
    Many NAM members, notably large multinational corporations, have 
developed important commercial relationships in China and seek to 
expand their share of the Chinese market. At the same time, a large 
number of members, particularly small companies, have expressed concern 
about increased import competition from China in the United States and 
currency and trade practices that give Chinese producers an unfair 
advantage.
    In several meetings on China over the past year, our members have 
told us that they want the United States to have a positive trade 
relationship with China. However, they also want a level playing field 
for competition. Manufacturers want the U.S. Government to deal firmly 
with unfair Chinese trade and currency practice. And they want the U.S. 
government to advance the long-term goal of providing U.S. companies 
with the same kind of access for U.S. goods and services in the Chinese 
market that Chinese goods and services enjoy in the U.S. market.
    U.S. manufacturers view China's membership in the WTO, which became 
effective in December 2001, as an important positive development. As a 
WTO member, China has now committed to abide by the same international 
trade rules that apply to the United States and most other countries. 
In addition, it has made significant commitments to open its internal 
market to foreign products and services in areas where the United 
States is highly competitive. The NAM supported China's membership and 
Permanent Normal Trade Relations (PNTR) status on the condition that 
China would adhere to these commitments and become a responsible 
participant in the international trading system.
    As China concludes its second year as a WTO member, its compliance 
record is decidedly mixed. While U.S. exports to China continue to 
increase (by 24 percent in January-June 2003) and a growing number of 
U.S. companies are trading and investing there, the NAM has also 
received far more complaints about unfair Chinese practices than in the 
previous year.
    NAM members recognize that China is still in transition to a market 
economy and in the process of phasing in certain WTO market-opening 
commitments. However, because China has quickly become such an 
important global importer and exporter, it is vital that the United 
States work to ensure that China complies with all WTO obligations and 
particularly those that have a significant impact on U.S. economic 
interests.

 CHINESE POLICIES THAT PROVIDE UNFAIR ADVANTAGES AND CREATE NONTARIFF 
                                BARRIERS

    In a recent survey, our members identified a variety of policies 
that have provided Chinese exporters with unfair trade advantages and 
created significant nontariff barriers that hinder market access for 
U.S. products in China. In the view of many manufacturers, China's 
undervalued currency is the single most important factor because it 
affects all Chinese exports and imports. Other policies also serve to 
limit U.S. exports to China and give Chinese products in the United 
States a competitive advantage. Taken together, these policies are 
making a significant contribution to the U.S.-China trade imbalance, 
which was $103 billion in 2002 and could reach $130 billion in 2003. 
The following section provides more details on individual issues of 
concern.

                         CURRENCY MANIPULATION

    By far, the NAM has received the greatest number of complaints 
about China's deliberate policy of undervaluing its currency to gain 
unfair competitive advantage over U.S. producers and those of other WTO 
member countries. Economists have estimated that China's currency could 
be undervalued by 40 percent or more. The Chinese yuan has remained 
pegged to the dollar at 8.28 for the past 8 years despite an extended 
period of robust economic growth, continuing trade surpluses and a 
large buildup in foreign exchange reserves, which exceeded $350 billion 
in July 2003. This level of foreign exchange reserves is, according to 
IMF analysis, far in excess of what would be required to cushion 
China's balance of payments from normal fluctuations in trade and 
investment flows.
    Pegging the yuan to the dollar appears to be part of a deliberate 
strategy to support Chinese industry and boost exports. This kind of 
currency undervaluation for commercial gain goes against the intent of 
the General Agreement on Tariffs and Trade (GATT), which seeks to 
remove trade barriers and allow markets to determine trade flows. 
Article IV, for example, states that ``Contracting Parties shall not, 
by exchange action, frustrate the intent of the provisions of this 
Agreement . . .'' China's undervalued currency acts as an additional 
trade barrier to U.S. exports and an unfair subsidy for all Chinese 
exports. We believe that Chinese exchange rate policies are not in 
accord with WTO obligations.
    The NAM appreciates efforts by the Bush Administration, 
particularly Treasury Secretary John Snow, to raise the importance of 
market-based exchange rates with Chinese leaders and obtain 
unprecedented support from other finance ministers in the G-7 and APEC. 
We are confident that a more flexible market-based exchange rate would 
result in a significant appreciation of the yuan against the dollar and 
help to level the playing field with Chinese producers both here at 
home and in the global marketplace. We strongly urge the Administration 
to continue to press the Chinese government to break the current peg 
and allow the yuan to move up to its true market value.

                           SUBSIDIZED EXPORTS

    We continue to receive reports from different industries (e.g., 
tool-and-die, metal forming, steel and chlorinated isocyanurates) that 
Chinese products are being sold in the United States at prices so low 
that they could not even cover the cost of raw materials and shipping 
much less full production and marketing costs. A tool-and-dye company, 
for example, reports that a Chinese competitor was selling a product 
similar to one made in the United States for $40,000, compared to the 
U.S. producer's price of $100,000. The U.S. company maintains that the 
cost of the raw 
materials alone would amount to $40,000, not including shipping, duties 
and other costs. A U.S. producer of chlorinated isocyanurates, which is 
used as a cleaning agent in swimming pools, reports a similar 
situation. As a result of pricing which appears to be below cost, 
Chinese exporters are expected to increase exports of this product by 
400 percent in 2003 over 2002 levels.
    These reports suggest the possibility of widespread use of 
subsidies, either direct or indirect, to help Chinese exporters gain 
unfair competitive advantage in the U.S. market. They merit further 
investigation by USTR and the Department of Commerce. One source of 
indirect subsidy is continued bank lending to money-losing and 
insolvent Chinese manufacturers, often state-owned or state-controlled 
enterprises. Since the Chinese banks providing these loans are either 
state-owned or state-controlled, the Chinese government bears 
responsibility for their lending practices. U.S. steel producers note 
that the Chinese steel industry is the largest recipient of interest 
rate subsidies authorized by the national government. Since many of the 
companies that benefit from either directed bank lending or subsidized 
interest rates are engaged in international trade, they have an unfair 
competitive advantage vis-a-vis U.S. based companies, which must rely 
on private financing at market rates.

      COUNTERFEITING AND INEFFECTIVE ENFORCEMENT OF IPR PROTECTION

    While Chinese laws on intellectual property rights (IPR) have 
improved considerably, the lack of effective enforcement of the IPR 
protection remains a serious problem. Violations of trademarks through 
product counterfeiting is rampant and on a massive scale. The 
violations involve a wide range of products, including consumer hygiene 
and health care products, athletic footwear, pharmaceuticals, food and 
beverages, motorized vehicles and even entire automobiles. 
Pharmaceutical counterfeiting is now, according to U.S. industry 
representatives, a serious public health concern in China. We believe 
that the lack of criminal penalties for counterfeiting, including 
jailing, prevents effective enforcement of trademark and labeling 
violations.
    We are also concerned about reports that local government 
authorities are actually promoting the expansion of local industry 
dedicated principally to counterfeiting. At a minimum, local 
authorities are knowledgeable of counterfeit production and taking no 
action to halt it. There appears to be no mechanism for the national 
government to prevent local governments from aiding and abetting 
counterfeiting by local industry. In addition, a member has reported 
that the Chinese customs service has not cooperated in blocking exports 
of counterfeit products even when solid evidence of counterfeiting was 
provided. It is claimed that, since the ``exporting'' of counterfeit 
products does not constitute a ``sale'' of the products, the relevant 
Chinese law did not apply.
    Other IPR violations are also common. They include unauthorized 
duplication of computer software, music and films; copying of designs; 
unauthorized use of patented technology; and unauthorized use of U.S. 
product certification logos. The makers of air conditioning and 
refrigeration equipment note that the ARI (Air-Conditioning and 
Refrigeration Institute) certification symbol was being used without 
authorization by a Chinese company. Efforts to have the Chinese 
government stop this unauthorized use proved ineffective.
    The pharmaceutical industry does, however, also report improvements 
in intellectual property protection, notably by the promulgation of a 
new regulation on data exclusivity for clinical trials, as required in 
TRIPS and committed in China's accession package.

                  MANIPULATION OF VAT AND OTHER TAXES

    We have reports that China is manipulating the application of 
taxes, notably the Value-Added Tax (VAT), to both restrict imports and 
indirectly subsidize exports. For example, the scrap recycling industry 
has told us that Chinese users of imported copper and other scrap 
metals are deliberating undervaluing their invoices to pay less VAT on 
the imported metal. When the finished metal products are exported, 
however, Chinese producers claim a rebate of the VAT based on the 
metals' real import price. This results in a substantial subsidy for 
the exported product that translates into lower prices in the U.S. 
market. It also enables Chinese scrap metal users to pay higher prices 
for scrap metal than their U.S. competitors. Chinese customs and tax 
authorities have not taken action to investigate these practices.
    We are also concerned about continuing Chinese discrimination in 
the application of the VAT on imported and domestically produced 
semiconductors. China levies a 17 percent VAT on imported integrated 
circuits. Domestically designed and produced integrated circuits are 
taxed at VAT rates ranging from 3-6 percent. Integrated circuits 
produced in China but designed abroad are taxed at 11 percent. This 
discriminatory treatment of domestic and foreign ``like'' products 
violates Article 3 of the GATT.

                   UNJUSTIFIED LABELING REQUIREMENTS

    In 2002 the Chinese Ministry of Health promulgated a new regulation 
mandating the labeling of all genetically modified (GM) food products. 
While the implementation of the regulation was subsequently suspended 
indefinitely, the fact that it remains on the books is already having 
significant adverse economic effects and creating barriers to trade. 
Some producers have ceased shipping these products in anticipation of 
the regulation going into effect.
    U.S. food producers have questioned whether the Health Ministry's 
action was in conformity with China's WTO obligations. The ministry did 
not provide a justification for the labeling requirement based on an 
assessment of health risks, which is a requirement of the Agreement on 
Sanitary and Phytosanitary Measures. The Technical Barriers to Trade 
Agreement (TBT) also suggests inadequate attention to the treatment of 
``like products,'' the question of whether the labeling requirement 
addresses a ``legitimate objective'' and the requirement to base 
technical regulations on ``performance'' rather than ``design'' 
characteristics.

       INAPPROPRIATE STANDARDS AND CONCERNS ABOUT CCC MARK SYSTEM

    Several NAM members have raised concerns about application of 
technical standards and the CCC Mark system. With regard to standards, 
China is requiring that certain products (e.g., electrical products) be 
manufactured only to ``international standards'' as determined in the 
ISO or IEC. Other ``international standards,'' notably those developed 
in the United States and widely used in the global marketplace, are not 
allowed. This does not conform with the WTO TBT Committee 
interpretation that ``international standards'' need not be limited to 
ISO or IEC standards.
    A second set of standards concerns relates to the CCC mark system. 
China introduced the CCC mark system to comply with WTO requirements 
for a single mark for like domestic and imported products. It is, in 
that sense, a step forward on standards and mark requirements. However, 
the inconsistent, non-transparent and inflexible application of the CCC 
Mark on a variety of products (e.g., electrical products, air 
conditioning and refrigeration equipment, and tires) has created market 
access barriers and needlessly raised the cost of importing products 
into China.
    Generic problems include: the high cost of having Chinese 
inspectors audit factories in the United States and other foreign 
countries on compliance with the standards; continued delays in 
allowing U.S. testing and certifying bodies to certify compliance for 
the CCC mark; and lengthy delays and relatively high cost of obtaining 
testing and certification for the CCC mark in China.
    Several other specific problems were noted. A major tire company 
reported that several types of its bus tires that are standard sizes in 
countries around the world cannot obtain the required CCC mark because 
these sizes are not listed in the Chinese National Standards. Another 
type of tire used widely on Chinese trucks is also not on the list and 
thus cannot be sold by the U.S. company in China. Efforts to resolve 
this problem with Chinese standards authorities and Chinese customs 
have thus far been unsuccessful. In addition, the company reports that 
local inspection offices appear to be abusing their authority by 
requiring the re-inspection of the company's Chinese-produced tires and 
confiscating tires which they determine to be ``non-compliant'' with 
the CCC mark standards.

             RESTRICTIONS ON TRADE RIGHTS OF JOINT VENTURES

    China is not fulfilling its commitment to allow foreign joint 
ventures to import and sell products (e.g., tires, automobiles, auto 
parts and industrial equipment) in China, which was to have gone into 
effect on Dec. 10, 2002. A major tire company, for example, reports 
that the Chinese government has imposed additional restrictions on its 
trading rights that were not anticipated when this concession was 
negotiated. They include allowing only new joint ventures to have this 
right and requiring the Chinese and foreign partners to have separately 
done U.S. $30 million in trade with China over each of the 3 preceding 
years.

              LACK OF ACTION ON AUTO FINANCING REGULATIONS

    The Chinese government has committed to publish new regulations 
governing the financing of automobile purchases. Several NAM member 
companies have expressed concern about slow progress on the regulations 
that were explicitly promised in China's accession agreement. The U.S. 
government should press for their prompt issuance to comply with WTO 
obligations.

            LACK OF TRANSPARENCY IN TRADE REGULATORY PROCESS

    Many companies complain about the lack of transparency in the trade 
regulatory process and the difficulty in obtaining current laws and 
regulations governing trade and business operations. This is a 
continuing problem that should lend itself to solutions in a relatively 
short time frame. The U.S. Government should press for concrete steps 
that improve transparency at all levels.

              POLICY CHANGES NEEDED BY THE U.S. GOVERNMENT

    U.S. agencies, particularly the Department of Commerce, Office of 
the U.S. Trade Representative and Treasury Department, have made good 
efforts to advance U.S. trade interests with China. Both Commerce and 
USTR are actively monitoring China's compliance with its commitments to 
abide by WTO rules and open its internal market in accordance with the 
provisions negotiated in the WTO membership agreement. They have 
welcomed input from the business community to assist in their analysis 
and assessments. The Treasury Department has also made important 
efforts to raise manufacturers' concerns about China's undervalued 
currency.
    The scope of the challenges in China, however, requires a much 
larger-scale effort than currently exists, with additional resources to 
address unfair trade and 
currency practices and support effective promotion of U.S. exports. The 
NAM recommends the following policy actions to meet these challenges:

1. Seek full WTO Compliance.--The U.S. Government must ensure that 
    China complies with its commitments as a new World Trade 
    Organization member to follow all international trade rules and 
    open its internal market in accordance with specific benchmarks set 
    forth in its membership agreement. Commerce and USTR need 
    additional resources to monitor and fully investigate WTO 
    compliance concerns and market access problems. Current resources 
    are inadequate to the task.
2. Stop Currency Undervaluation.--We must continue to press China to 
    end the 
    manipulation of its currency and allow the yuan/dollar exchange 
    rate to be determined by the market forces. Secretary Snow's visit 
    was an excellent start in raising the issues, but we need to keep 
    the pressure on China and get other affected countries (e.g., our 
    G-7 partners) to join us. The NAM is prepared to support a Section 
    301 trade complaint in concert with other members of the Sound 
    Dollar Coalition as a way of underscoring the seriousness of the 
    matter and the need for a credible Chinese response.
3. End Subsidized and Non-Market Production.--We hear too many reports 
    from NAM members that Chinese imports are far below the cost of 
    production based on international prices for raw material inputs. 
    These charges merit more detailed investigation. In our dialog with 
    China, we must insist that the prices of traded goods are 
    determined by real economic costs and not costs artificially set by 
    the government.
4. Address Counterfeiting and IPR Violations.--We must take firm 
    actions to end China's rampant counterfeiting of U.S. and other 
    foreign products. Today China is the epicenter of world 
    counterfeiting, costing us tens of billions of dollars in lost 
    exports and the related jobs. At both the national and local 
    levels, the Chinese government is ignoring the blatant 
    counterfeiting of U.S. products and taking no action to prevent 
    this. The U.S. Government needs to engage in a frank dialog with 
    Chinese authorities on the need to address the problem of 
    counterfeiting and other intellectual property rights violations 
    and take action under U.S. trade law when problems are not 
    resolved.
5. Expand Export Promotion to Support U.S. Business.--Finally, the 
    United States needs to undertake a large-scale joint public-private 
    export trade effort to increase U.S. exports to China. In 2003, 
    China is set to become the world's 3rd largest importer ($380 
    billion) but the United States only has an 8 percent share of all 
    Chinese imports. U.S. companies need to increase their marketing 
    efforts but greatly expanded Commerce Department and other 
    promotion assistance is also needed. We recommend a network of low-
    cost American business centers throughout China to help U.S. 
    companies overcome the many unique barriers to doing business in 
    China (e.g., language, cultural, communication and infrastructure) 
    and access rapidly growing urban areas in the country's interior.

    A balanced strategy that emphasizes stricter compliance with trade 
rules, an end to currency undervaluation and improved market access 
will not only help U.S. manufacturers compete on a level playing field 
but also place the U.S.-China trade relationship on a more stable 
footing for long-term development.
    Thank you for giving the NAM the opportunity to testify today.
                                 ______
                                 

                 Prepared Statement of Lawrence J. Lau

                           SEPTEMBER 24, 2003

    Mr. Chairman, Mr. Co-Chairman, distinguished commissioners, ladies 
and gentlemen. It is a great honor for me to have the opportunity to 
testify before your Commission. As recommended by your Commission 
staff, I shall focus on the U.S.-China trade imbalance and whether the 
imbalance can be corrected by a revaluation of the Renminbi, the 
Chinese currency, vis-a-vis the U.S. Dollar.
    The Chinese trade surplus in goods and services vis-a-vis the 
United States is large and growing. Official U.S. data overestimate the 
Chinese surplus and official Chinese data underestimate the Chinese 
surplus because of their different treatments of re-exports through 
Hong Kong and other trans-shipment points. Prof. K.C. Fung, of the 
University of California at Santa Cruz and I have adjusted the data of 
both countries and derived adjusted estimates of the U.S.-China trade 
imbalance. For 2002, our best estimate of the Chinese trade surplus for 
goods and services combined is US$74.3 billion (see Appendix Table 1).
    However, despite the large Chinese trade surplus vis-a-vis the 
United States, the overall Chinese trade surplus with the World as a 
whole is relatively small, and has been becoming smaller, especially 
after Chinese accession to the World Trade Organization (WTO). It is 
projected to be approximately US$10 billion for 2003, or 1.5 percent of 
total Chinese international trade. This implies that China will have a 
trade deficit with the rest of the World, which is projected to be on 
the order of US$70 billion for 2003. The trade surplus vis-a-vis the 
United States is projected to be in the US$80 billion range.
    In contrast, Japan has a large trade surplus both with the United 
States and the World as a whole. For 2002, Japan has a trade surplus of 
approximately US$62 billion with the United States and a trade surplus 
of approximately US$80 billion with the World as a whole. Its balance 
of payments, on a current-account basis, is thus much more out of 
equilibrium than China's.
    Moreover, the Chinese exports to the United States have mostly 
originated from foreign- (including U.S.) invested enterprises in China 
or Chinese subcontractors to foreign firms and are the direct 
consequences of the rapid expansion of global outsourcing and division 
of labor made possible by the revolution in information and 
communication technology. In addition, a large proportion, over 50 
percent, of the Chinese export operations consists of ``processing and 
assembly'' activities--the final assembly/finishing of products using 
intermediate inputs produced elsewhere. What used to be exported from 
Japan, Hong Kong, South Korea and Taiwan to the United States are now 
increasingly finally finished and exported from China, using components 
and parts supplied by these economies and elsewhere. The continuing 
growth of the Chinese trade surplus with the United States is a direct 
consequence of the shifting of the location of final assembly/finishing 
of many goods from these East Asian economies to China. The finished 
goods are considered to have originated from China when they are 
exported to their final users from China. As a result, simultaneous 
with the rise of the Chinese trade surplus with the United States, the 
trade surpluses of these other East Asian economies vis-a-vis the 
United States decline, or stop growing, and the trade surpluses of 
these economies with China rise. In other words, a significant part of 
the trade surpluses that these economies once had with the United 
States have been shifted to and ``inherited'' by China (see Appendix 
Table 2). For example, during the first half of 2003, China had trade 
deficits of US$7 billion, US$10 billion, US$18 billion and US$7 billion 
with Japan, South Korea, Taiwan and the ASEAN countries respectively 
(see Appendix Table 3). The Chinese trade deficit in goods and services 
vis-a-vis the rest of the World may be expected to continue to rise in 
the future because of the rapid growth of oil imports (driven by 
rapidly increasing domestic demand for automobiles) and outbound 
tourism.
    However, precisely because the Chinese firms are mostly engaged in 
assembly/finishing operations, despite the high gross value of Chinese 
exports, the domestic value-added content of Chinese exports to the 
United States is low--it may be estimated at 20 percent. (Equivalently, 
the import content of Chinese exports to the United States is a high 80 
percent.) The domestic value-added content of Chinese exports to the 
World is higher, at 30 percent. Chinese exports to the United States 
may be estimated to be no more than 10 percent of Chinese GDP. (Chinese 
exports to the World are not quite 30 percent of Chinese GDP.) Thus, 
the Chinese GDP attributable to Chinese exports to the United States is 
no more than 2 percent. The percent of Chinese GNP attributable to 
Chinese exports to the United States is most likely even smaller 
because most of the profits from such exports accrue to the foreign 
shareholders and owners of the exporting enterprises and clients of 
Chinese subcontractor firms.
    Yet, this global outsourcing of the assembly/finishing operations, 
which require relatively low skill levels, to the lowest cost 
subcontractors, also strengthens the competitiveness of U.S. firms in 
their home markets and helps them to not only maintain their existing 
markets but also open new markets for U.S. products in the rest of the 
world. For examples, Dell may not have been able to compete with Acer 
without the cost savings resulting from the final assembly of its 
personal computers in China (typically by its contractor); Motorola may 
not have been able to compete with Samsung without its production and 
export base for mobile telephones in China; and Hewlett-Packard may not 
be able to compete with Epson without manufacturing overseas. 
Competition is worldwide today and not just limited to U.S. 
markets. However, as mentioned previously, the Chinese value-added is 
very low because almost all components and parts, especially the high-
value ones, are imported. Thus, while China may have the dubious honor 
of being the world's largest shoe manufacturer, Nike has become the 
world's most profitable footwear firm without manufacturing a single 
pair of shoes. More generally, the global outsourcing enables U.S. 
firms to both maintain their domestic market shares and expand their 
global market shares and thereby maintain, create and expand better-
paying job opportunities in the United States. The bulk of the jobs won 
by Chinese workers as a result of global outsourcing were from the 
other East Asian economies, and not from the United States--we lost 
those decades ago.
    The fact that Chinese exports have a low domestic value-added 
content has a couple of important implications. The first has to do 
with the relative gains from trade. The domestic value-added content of 
Chinese exports to the United States, as mentioned above, is only 20 
percent. The domestic value-added content of U.S. exports to China is 
much higher. (The top 5 U.S. exports to China in 2002 are: (1) Aircraft 
and associated equipment; (2) Thermionic, Cold Cathode and Photocathode 
Valves; (3) Telecommunication Equipment; (4) Oil Seeds and Oleaginous 
Fruit; and (5) Measuring/Checking/Analysing Instruments.) The adjusted 
Chinese exports to the United States is approximately US$105 billion, 
f.o.b. and the adjusted U.S. exports to China is approximately US$27.5 
billion, f.o.b. If we assume the U.S. domestic value-added content is 
60 percent, then the domestic value-added of Chinese exports to the 
United States is US$21 billion and the domestic value-added of U.S. 
exports to China is US$18.5 billion. These two numbers are not that far 
apart and 60 percent may well be an under-estimate of the domestic 
value-added content of U.S. exports to China. In terms of value-added 
created in each country, the gains from trade between U.S. and China 
seem not to be too inequitably distributed.\1\
---------------------------------------------------------------------------
    \1\ In addition, the United States has a surplus in trade in 
services of more than US$ 2 billion, and there the domestic value-added 
content is almost 100 percent.
---------------------------------------------------------------------------
    The second has to do with the potential effectiveness of a 
revaluation in the exchange rate of the Renminbi, the Chinese currency, 
in reducing Chinese exports to the United States and thereby stemming 
the loss of jobs. The low domestic value-added content of Chinese 
exports to the United States implies a high import content. Thus, a 
revaluation of the Renminbi, while it raises the cost of processing and 
assembly in China, also lowers the cost of the imported intermediate 
inputs, which constitute 80 percent of the total cost of the product, 
at the same time. A 10-percent revaluation will therefore increase the 
cost of Chinese exports to U.S. importers by approximately 2 percent. 
It is therefore unlikely to have a significant effect in reducing 
Chinese exports to the United States. The postwar Japanese experience 
is hardly encouraging on this question. The Japanese Yen appreciated 
from 360 Yen/US$ in the early 1960s to its current 115 Yen/US$, but the 
revaluation did not seem to have reduced the Japanese trade surplus 
vis-a-vis the United States. Mere revaluation of an exchange rate 
seldom works and will not in this case. It is far more 
important, and effective, to change the mercantilist mindset prevalent 
in these countries.
    There are also additional reasons why a revaluation of the Renminbi 
is unlikely to help very much. Most macroeconomists will tell us that 
our trade deficit is the direct consequence of our savings-investment 
imbalance, that unless we save more and consume less, the balance of 
payment deficit is likely to continue. Even if the Renminbi is 
significantly revalued, and the revaluation is effective in raising the 
prices of Chinese exports, it may merely lead to diversion of 
processing and assembly activities from China to third countries with 
similarly low costs.
    China and the United States do not compete in any export markets. 
The U.S. does not export anything that China exports. Similarly, China 
does not export anything that the United States exports. The two 
economies are actually quite complementary. In terms of reducing the 
U.S. trade deficit, it is far more effective to have a revaluation of 
the currencies of countries that compete directly with the United 
States in export markets, which should increase U.S. exports. For third 
countries like China, it is not the values of their exchange rates vis-
a-vis the U.S.$ that determine whether they will buy from Airbus or 
Boeing, it is the Euro/US$ exchange rate. Finally, a precipitous 
revaluation of the Renminbi may lead to a flight from the US$ by 
Chinese nationals, possibly driving up the rate of interest in the 
United States.
    We may note that both Dr. Glenn Hubbard, the former Chairman of the 
Council of Economic Advisers, and Dr. Gregory Mankiw, the current 
Chairman of the Council of Economic Advisers, have said that a 
revaluation of the Renminbi is unlikely to be very effective in 
reducing job losses in the United States.
    Revaluation of the Renminbi, even unaccompanied by the removal of 
outbound capital control, is also likely to pose some risks to the 
financial institutions and enterprises in China because of the 
requirement of ``marking to market.'' For example, the People's Bank of 
China (PBOC), the central bank, holds approximately US$360 billion of 
foreign exchange reserves, with perhaps more than 70 percent of which 
denominated in US$. It will have to take a massive write-down in 
Renminbi terms upon revaluation. (PBOC holds approximately US$126 
billion of Treasury securities, and also Fanny Mae and Freddy Mac 
securities.). It has been estimated that an additional US$150 billion 
are held by Chinese enterprises and households as deposits at Chinese 
commercial banks. A full-fledged banking crisis may ensue if Chinese 
commercial banks have to write down their currency losses.
    It is probably counterproductive for the United States to demand 
that China do something that is costly to China but does not do the 
United States any good. Forcing China to revalue does not really help 
us solve our job problem fundamentally.
    We next address the question of whether the market for foreign 
exchange in China is in equilibrium (a related question is whether the 
Renminbi is undervalued). There actually has been a cumulative real 
exchange rate appreciation of the Renminbi versus the U.S. Dollar of 
approximately 15 percent since January 1, 1994. The Chinese current 
accounts are at the present time approximately balanced vis-a-vis the 
World as a whole despite large surpluses vis-a-vis the United States, 
with only a small surplus of approximately US$10 billion expected for 
2003. However, the Chinese overall balance of payments is in 
disequilibrium with a significant surplus, mostly because of the large 
capital inflow on account of the inbound foreign direct investment 
(FDI), currently running at a rate of US$60 billion a year. But the 
capital accounts are in surplus also because of controls on capital 
outflows. Only inflows of capital but no outflows of capital are 
permitted (with some exceptions) in China. Thus, while it is true that 
the Renminbi exchange rate is not ``market-determined'' by spot supply 
and demand, whatever exchange rate that may emerge from simply 
eliminating the government intervention in the foreign exchange market 
is not a truly market-determined exchange rate either, because many 
potential buyers of foreign exchange and sellers of Renminbi have been 
excluded. If capital controls are lifted tomorrow, it is not clear that 
the Yuan will appreciate. Dr. Nicholas Lardy of the Institute for 
International Economics, Dr. Stephen Roach of the Morgan Stanley, and 
Dr. Weijian Shan, a General Partner of Newbridge Capital all seemed to 
believe that the value of the Yuan in terms of U.S. Dollars will go 
down, not up, if capital controls are lifted. I personally do not share 
their view. However, lifting capital controls abruptly is extremely 
risky--it may trigger a massive financial crisis in China. If Chinese 
depositors withdraw their deposits from the Chinese commercial banks 
and exchange them into U.S. Dollars en masse, the commercial banks may 
be faced with an illiquidity and insolvency crisis, because of the 
extraordinarily high proportion of nonperforming loans in their 
portfolios. In addition, the apparently large official foreign exchange 
reserves held by China can be very quickly depleted, putting great 
downward pressure on the Renminbi. Standard and Poor, the rating 
agency, supports the decision of China not to revalue the Yuan on the 
grounds that a floating of the currency will damage China's credit 
rating.
    One can of course also try to correct the disequilibrium in the 
foreign exchange market through quantity adjustments rather than price 
adjustments, i.e., revaluation. Quantity adjustments imply increasing 
the imports of goods and services, promoting outbound direct and 
portfolio investment, and financing inbound direct (and even portfolio) 
investment with Renminbi-denominated loans. But above all, it means 
changing the mercantilist/fish-trap mentality.
    First, China can afford to run a significant trade deficit, given 
its substantial foreign direct investment inflow, and it can and should 
import more from the United States. The trade imbalance can be 
corrected in two ways--decreasing imports or increasing exports. Rather 
than making the Chinese sell less to us, it is far better for us to 
encourage them to buy more from us. Given the levels of Chinese exports 
and imports and external debt levels relative to its GDP, there is no 
need for the Chinese central bank to continue to accumulate foreign 
exchange reserves. One caricature of what has been happening for the 
last few years is the following: Chinese firms exchange goods for 
greenbacks, pieces of paper that can be printed at virtually zero cost; 
they sell the greenbacks to the Chinese central bank for Renminbi; and 
the central bank in turn exchanges the greenbacks for other pieces of 
paper, call bonds, which can also be printed at virtually zero cost. 
Holding too much paper is not without risk. At some point the Chinese 
should turn back some of the pieces of paper for some real goods. 
Special high-end consumer products, such as Harley-Davidson motor 
cycles and Corvette cars, can have a significant market in China, but 
require promotion. There is also always a high demand for high 
technology capital goods, and perhaps an expedited procedure for 
processing applications for export control waiver can help. U. S. firms 
can also provide more services to China, in the areas of 
telecommunications, transportation, logistics and distribution 
activities, financial services, and e-Commerce. Leisure time activities 
and entertainment--sports exhibition, movies, etc.--are another 
promising area. There is also a great deal of room for growth in the 
provision of invisible/intangible ``exports'' of services--tourism 
(China has really opened up tourism in a big way--travelers are 
permitted to take US$5,000 out of the country per person per trip; 
individuals can now have passports that are valid for years as opposed 
to just a single trip; and individual tourism is now a legitimate 
reason for traveling abroad); education (more Chinese students for 
universities and graduate schools in the United States), and healthcare 
(medical treatment) in the United States. Finally, enhanced 
intellectual property rights protection in China can greatly augment 
U.S. exports of goods and services to China.
    China can also offer to finance the inbound foreign direct 
investment (FDI) of foreign direct investors with Renminbi-denominated 
loans, providing a natural hedge to foreign direct investors but at the 
same time reducing the inflow of foreign exchange, which China, with a 
savings rate of 40 percent, does not need (such loans, however, must be 
with recourse to the ultimate parents in order to avoid moral hazard). 
China can also make it easier for foreign direct investors to 
repatriate their principal and profits. Outbound foreign direct 
investment, especially strategic foreign direct investment, should be 
promoted and encouraged. For example, Chinese textile firms may be 
encouraged to invest in the U.S. textile industry. There may well be 
complementarities and synergies between industries on the decline in 
one country but on the rise in the other. Many of the benefits and 
costs of international trade can be internalized. In particular, the 
potentially displaced workers can be compensated by the potential 
beneficiaries of the trade, who can, in turn, pass the cost to the 
general public by charging slightly higher prices. Chinese firms can 
also be encouraged to make strategic investments in listed and unlisted 
companies in the United States and elsewhere. Tax treaties should be 
concluded between China and the United States and other countries so as 
to facilitate Chinese outbound foreign direct investment. China can 
also increase foreign aid and foreign loans to multilateral 
organizations and low-income developing economies--e.g., loans 
repayable in the local currency.
    Instead of floating their shares on the overseas markets, good 
Chinese firms should be encouraged to offer their shares domestically 
(China does not need any more foreign exchange), where in fact the 
price/earnings ratios are much higher. China should also begin to relax 
its capital control by allowing regulated orderly outflows of portfolio 
investments through approved instruments or vehicles, e.g., qualified 
domestic institutional investors (QDIIs), closed-end outbound publicly 
listed and traded mutual funds (e.g., S&P500 indeed funds), and China 
Depositary Receipts issued by U.S. and other foreign publicly listed 
companies and listed and traded on the Chinese Stock Exchanges.
    Are there other promising alternatives for reducing the 
disequilibrium in the overall balance of payments to a revaluation? The 
answer is yes. First, an acceleration of the World Trade Organization 
(WTO) commitments on tariffs, market access and opening can be 
extremely helpful. Second, the imposition of import tariffs by the 
United States. However, this may not be very effective, because the 
supply of imports can simply come from another country. And 
discriminatory import tariffs may not be permitted under WTO rules.
    A potentially interesting idea is that of ``Voluntary Export Tax 
(VET)''. Export taxes are generally permitted under WTO rules (either 
vis-a-vis the United States or vis-a-vis the rest of the World). An 
export tax is better for China than a revaluation because while it 
enhances the terms of trade in the same way as a revaluation but it 
does not lead to losses for holders of the U.S. dollars, e.g., the 
People's Bank of China or other commercial banks and enterprises that 
may have to recognize the foreign exchange losses. It also does not 
generate windfall gains for the holders of the Renminbi and thus does 
not reward currency speculators or encourage continuing currency 
speculation. Moreover, an export tax can be easily lifted if and when 
the balance of payments conditions so warrant. For the United States 
and other importers of Chinese goods, an export tax of 2 percent is 
equivalent to a revaluation of 10 percent. An import subsidy also has 
the same effects on trade flows as a revaluation or an export tax. 
However, from a fiscal point of view, an export tax is preferable 
because it generates revenue whereas an import subsidy requires 
expenditure.
    Volatility of the exchange rate is not conducive to long-term trade 
and investment relations--long term effective hedges are hard to find 
and expensive. However, a wider band of fluctuation around a stable 
mean exchange rate is a good idea but should be introduced and 
implemented only when expectations of future exchange rates are more 
neutral and diffuse. If expectations are all one-sided, introducing a 
wider band does not help because the top of the band will be reached 
immediately, possibly leading to expectations of even further movements 
in the same direction. China should not revalue now, because then it 
will encourage continuing speculation and pressure to revalue. 
Moreover, it is always easier to revalue than to devalue. Devaluation 
is likely to face much more opposition than a revaluation. The U.S. may 
object, assuming that it continues to be in a net deficit position. 
Objections and competitive devaluation by other exporting countries 
competing in the same markets can be expected with a devaluation but 
not with a revaluation. Finally; the perception of the domestic 
population may pose an obstacle to devaluation because the currency is 
also regarded as a store of value and devaluation may be regarded as a 
sign of weakness of the economy or mismanagement. When the long-term 
value of the currency is uncertain, as is the case for the Renminbi, it 
is better to stay put rather than revalue or devalue.
    The best strategy for us is probably to focus on achieving the 
outcome that we want, e.g., an overall Chinese balance of payments of 
approximately zero, and not on the method for achieving it.\2\ We 
should hold China to the achievement of the outcome, but leave the 
choice of instrument, or combination of instruments, to China. We have 
advised the Japanese Government to revalue the Japanese Yen quite a few 
times, which it dutifully did each time, but the revaluations never 
achieved the desired outcome--a reduction or elimination of the large 
Japan-U.S. trade surplus--the trade surplus only became bigger. We 
should have asked the Japanese Government to simply reduce its overall 
balance of payments surplus, in whichever way that it thinks it can.
---------------------------------------------------------------------------
    \2\ Of course, a Chinese overall balance of payments of zero, while 
it implies that China will have a significant deficit in the current 
accounts (principally the trade in goods and services) with the World 
as a whole, it does not necessarily imply that the U.S.-China bilateral 
trade deficit will be smaller. However, the expectation is that the 
overall trade deficit of the United States vis-a-vis the World as a 
whole will be reduced as China or other economies, making use of their 
trade surpluses with China, increase their imports from the United 
States.
---------------------------------------------------------------------------
    Chinese economic policymakers are committed to the gradual 
evolution to a market based exchange rate determination mechanism. 
Going forward, the most important task facing the Chinese economic 
policymakers is to lay the groundwork for the orderly and regulated 
relaxation of the controls on the different types of capital 
outflows, with the objective of achieving an equilibrium in the overall 
balance of payments. Then gradually, with the overall balance of 
payments continuing to be in approximate equilibrium, additional types 
and higher volumes of capital outflows can be liberalized until the 
ultimate objective of free convertibility is achieved.

                            Appendix Tables

 Table 1.--Estimate of U.S.-China Trade Balance, f.o.b., Adjusted for Re-exports, Re-export Markups and Services
                                                (Billions of US$)
----------------------------------------------------------------------------------------------------------------
                Our estimate of     Our estimate of
               U.S. imports from    U.S. exports to    Estimate of U.S.    Estimate of U.S.     Our estimate of
              China fob adjusted  China fob adjusted      exports of          imports of       U.S.-China trade
    Year      for re-exports and  for re-exports and   services to China     services from     balance of goods
               re-export markups   re-export markups    (Official U.S.      China (Official      and services
                (Official U.S.      (Official U.S.           data)            U.S. data)        (Official U.S.
                     data)               data)                                                       data)
----------------------------------------------------------------------------------------------------------------
      1995                33.7                16.0                 2.5                 1.7               -16.9
      1996                38.7                17.1                 3.2                 1.9               -20.3
      1997                48.2                18.0                 3.6                 2.2               -28.8
      1998                56.3                18.9                 4.0                 2.3               -35.7
      1999                65.1                17.7                 3.9                 2.7               -46.2
      2000                80.3                21.4                 4.6                 2.8               -57.1
      2001                83.5                24.7                 5.3                 3.0               -56.5
      2002               104.0                27.4                 5.3                 3.0               -74.3
----------------------------------------------------------------------------------------------------------------
Sources: Fung and Lau ``Adjusted Estimates of United States-China Bilateral Trade Balances: 1995-2002,'' Asian
  Economic Journal, Vol. 14, May/June 2003, pp. 489-496.
Note: The official 2002 U.S. data on exports and imports of services are not yet available. We make the
  assumption that the values of export and import service trade between the United States and China are the same
  in 2002 as in 2001.


                     Table 2.--U.S. Balance of Trade
                            (Billions of US$)
------------------------------------------------------------------------
                                 2000       2001       2002      2003H1
------------------------------------------------------------------------
World.......................     ($487)     ($448)     ($509)     ($268)
China.......................      ($90)      ($90)     ($111)      ($54)
Japan.......................      ($85)      ($72)      ($73)      ($32)
Hong Kong...................         $3         $4         $3         $2
South Korea.................      ($14)      ($14)      ($14)       ($5)
Taiwan......................      ($15)      ($15)      ($14)       ($7)
------------------------------------------------------------------------


                   Table 3.--Chinese Balance of Trade
                            (Billions of US$)
------------------------------------------------------------------------
                                 2000       2001       2002      2003H1
------------------------------------------------------------------------
World.......................        $43        $23        $30         $3
United States...............        $30        $28        $43        $23
Japan.......................         $0         $2         $6       ($7)
Hong Kong...................        $35        $37        $26        $27
South Korea.................      ($12)      ($11)      ($11)
Taiwan......................                 ($12)      ($36)      ($18)
------------------------------------------------------------------------

               Prepared Statement of Margaret M. Pearson

                           SEPTEMBER 24, 2003

    Mr. Chairman, Mr. Co-Chairman, and Members of the Commission:
    Thank you for the opportunity to testify before you today. I am a 
Professor in the Department of Government and Politics at the 
University of Maryland. I have been researching and teaching on China's 
politics and economy since the mid-1980s, first at Dartmouth College 
and now at the University of Maryland. One of my areas of expertise is 
China's participation in the World Trade Organization (WTO).
    In my testimony today I wish to address two issues related to 
China's rule of law development, which is of course a core part of the 
Commission's mandate. The first half of my comments addresses the 
implementation of China's WTO-related rule-of-law commitments as they 
are carried out in domestic legal arena. The second part of my 
testimony addresses China's adherence to international standards in its 
participation in the WTO in Geneva and related meetings, with 
particular attention to the recent WTO Ministerial in Cancun.

   I. UNEVEN PROGRESS ON CHINA'S WTO-RELATED RULE OF LAW COMMITMENTS

    On the first topic--domestic rule of law commitments--I will focus 
my attention on two subjects: promulgation of rules required by China's 
WTO accession documents, and development of mechanisms and norms of 
transparency. I give some attention to where we are in ``year 2'' of 
China's membership, but remain cognizant that the real and enduring 
processes the Commission is interested in require we think with a 
longer-term metric in mind.
    My basic assessment, which I believe is consistent with that of 
many scholars and practitioners who follow legal developments as they 
relate to WTO, is that the trends in these areas have not changed much 
since the Commission issued its Annual Report for 2002. It remains the 
case that over the past decade China has made great strides in 
strengthening many aspects of its legal system, including as this 
system applies to WTO compliance. Despite substantial progress, 
however, there is no question that China has a long way to go toward 
fulfilling its commitment on rule-of-law related issues. Its ability to 
do so routinely will depend on continued evolution of the overall move 
toward rule of law in the legal system as a whole.
    With regard to the promulgation of rules required by China's 
accession, as has frequently been noted, the Chinese government has 
established or revised many laws committed to in its WTO accession 
agreement.\1\ Still, we continue to await promulgation of many rules 
for specific industries. Even where broad laws have been promulgated, 
detailed implementing rules on market access for foreign firms have not 
appeared. For example, in year 2 (by December 11) China's WTO accession 
agreement mandates that several sets of regulations on services be 
promulgated, but it is not clear that they will be ready.\2\ More 
generally, the pace of law-making and revising has slowed substantially 
compared to 2 years ago. This slowing is in part because much already 
has been done, but it also reflects the fact that more difficult and 
controversial areas are being approached. As time passes, moreover, 
domestic economic constituencies have mobilized themselves, often in 
the form of industry associations, and have erected protectionist 
barriers. Furthermore, new rules that erect new trade barriers, such as 
on genetically modified organisms (GMOs) and other sanitary and 
phytosanitary concerns, are being issued. Not all will be judged WTO 
non-compliant, but some certainly will.
---------------------------------------------------------------------------
    \1\ In 2000-2002, China's governmental agencies went through a 
massive review process aimed at determining which of China's 
regulations were WTO-compliant. In May 2002 China's Ministry of Foreign 
Trade and Economic Cooperation (now part of the Ministry of Commerce) 
announced that more than 2,300 laws and regulations had been amended to 
comply with WTO rules, and 830 additional laws and regulations had been 
abolished.
    \2\ For example, the WTO mandates the promulgation of regulations 
on direct selling services by December 11, 2003.
---------------------------------------------------------------------------
    The issue of transparency has received significant attention from 
the Commission. China's WTO commitments speak explicitly to the issue 
of transparency by requiring that all regulations related to its WTO 
commitments be published promptly and in official accessible venues, 
and that prior to promulgation they be published in draft form and 
subject to public comment (including by foreign interests).\3\ In this 
realm of administrative law and procedure, the Chinese government has 
made progress in encouraging that laws are published, transparent, 
promulgated only after some public comment period, and so forth. Prompt 
publication of formally issued laws has proceeded especially well; one 
hears of fewer and fewer instances where foreign businesses are told of 
an internal (neibu) regulation or administrative circular that they 
must abide by yet may not see. There continue to be more instances 
where drafts have been circulated for public comment with sufficient 
(if still short) time to receive comment. Some regulatory agencies--
notably the China Securities Regulatory Commission--seem quite 
committed to these procedures.
---------------------------------------------------------------------------
    \3\ The Commission ably summarized these requirements in its 2002 
Annual Report (p. 47).
---------------------------------------------------------------------------
    Nevertheless, many of the same gaps the Commission found in its 
2002 Annual Report remain. In particular, the adherence to the public 
comment commitment is uneven.\4\ Too often, binding rules that 
significantly affect market access are issued without opportunity for 
comment, as occurred this year with the 2003 Telecommunications Service 
Classification Catalog.\5\ Draft rules continue to circulate without a 
mechanism for formal comment.\6\ Sometimes drafts are circulated only 
among a few companies (foreign or domestic), often just those former 
government monopolies with close ties to the regulator. Public comment 
periods, even when offered to a broad range of Chinese and foreign 
companies, are often too short. Many observers had also hoped that the 
WTO-based requirements for transparency also would help open the policy 
formulating process to greater scrutiny, though this is not mandated by 
WTO. There continues to be disappointment on this front as well.
---------------------------------------------------------------------------
    \4\ One recent example that has received much attention is that 
when China revised its auto policy regulations it did not issue the 
drafts publicly or provide foreign companies an opportunity to comment.
    \5\ The catalog was posted on the Ministry of Information Industry 
web site with an effective date 2 weeks following release and no 
vehicle for soliciting comment. This catalog is crucial because it 
classifies telecommunications services into basic services and value-
added services, a distinction of great importance to foreign firms 
because, for example, the former category is much more protected than 
the latter.
    \6\ This has been reported with regard to draft laws on retail, 
franchise and direct selling. See US-China Business Council, ``China's 
WTO-Implementation: A Mid-Year Assessment'' (US-China Business Council, 
2003).
---------------------------------------------------------------------------
    China has committed to these transparency norms and to the 
promulgation regulations that enshrine the principles of market access 
and national treatment. Difficulty in adhering to these commitments 
cannot be excused. But the difficulties can be explained. To what, 
then, can we attribute this continued slow implementation? At this 
point, substantial education of officials--funded by the Chinese 
government and foreign public and private sources--has been completed. 
It is no longer compelling to attribute the gaps to a lack of 
understanding.\7\ Several explanations are more compelling at this 
juncture. First, there continue to be poor coordination mechanisms 
between the myriad agencies that often must be involved in the 
promulgation of any new rules. Indeed, while there is often a lead 
agency for drafting, another agency or set of agencies may do the 
issuing of the rule. Poor ability to coordinate internally can easily 
spill out to poor coordination on the external comment requirements. 
Bureaucracies may shy away from public comment and prior notice, even 
though they are not required to do anything with the comments, because 
they complicate the internal negotiations and bureaucratic wrangling 
that accompanies the promulgation of many new rules.
---------------------------------------------------------------------------
    \7\ This is not to say that much can be done to build capacity in 
important areas--notably in the areas of judicial review and 
enforcement of regulations.
---------------------------------------------------------------------------
    A second structural obstacle to implementation of rule of law 
obligations is the ongoing administrative reorganization. I refer not 
merely to the immediate past reorganization following the National 
People's Congress in March 2003,\8\ but more generally the longer term 
establishment of new regulatory agencies and re-division of authority 
between existing ministries, bureaus, etc. The administrative lines of 
authority remain unclear and poorly institutionalized, and continue to 
make the rulemaking process quite contentious.
---------------------------------------------------------------------------
    \8\ The most pertinent example is the combination of the Ministry 
of Foreign Trade and 
Economic Relations (MOFTEC), which has lead responsibility for many 
aspects of WTO implementation, with the State Economic and Trade 
Commission (SETC) into a new Ministry of Commerce.
---------------------------------------------------------------------------
    Finally, the norm of transparency, though gaining ground 
domestically, is not yet reflexive. Not until the norm is fully 
grounded in domestic law will it to become an entrenched part of the 
domestic legal and administrative landscape. The promulgation of an 
Administrative Procedure Law, now in draft form, is expected to lay out 
detailed procedures that administrative units must follow, including 
procedures to enhance transparency.\9\ A similar slow process appears 
to be underway with regard to establishment of independent judicial 
review of WTO-related administrative 
actions.\10\
---------------------------------------------------------------------------
    \9\ On the importance of incorporating China's WTO obligations in 
domestic law to be fully 
authoritative, see Donald C. Clarke, ``China's Legal System and the 
WTO: Prospects for Compliance,'' Global Studies Law Review, 2003.
    \10\ On independent judicial review of WTO-related administrative 
actions, I refer the Commissioners to the study by Veron Mei-Ying Hung, 
``China's WTO Commitment on Independent Judicial Review: An Opportunity 
for Political Reform,'' Working Paper Number 32 (Washington D.C.: 
Carnegie Endowment for International Peace, November 2002). Hung 
discusses the moves made toward establishing independent judicial 
review by basing it on the Administrative Litigation Law, but also 
notes the political constraints in achieving such independent review 
that can only be solved in the longer term and as a result of broader 
political reforms.
---------------------------------------------------------------------------
    Thus, while it is still possible to point in year 2 to progress in 
the rule-of-law domain, the unevenness that has been present throughout 
the compliance process remains. The continuing unevenness, deadline 
missing, and so forth, is generating greater anxiety and disappointment 
in the foreign community than it was a year ago, as it appears that these problems are in danger of becoming a permanent part of the implementation process and not merely a reflection of first-year missteps or even 
leadership transition and SARS. Goodwill is dissipating among many foreign 
observers and business interests.
    Amidst this frustration, it is worth repeating that deep and 
enduring progress on many of the rule of law issues of concern to the 
Commission--not just as regards China's WTO compliance, but also more 
broadly reform of legal procedures and processes, improvement in 
transparency, establishment of an independent judiciary, and so forth--
are, and will continue to be, driven foremost by internal processes. By 
internal processes I refer primarily to the development of domestic 
constituencies, either within or outside of the government, with an 
interest in seeing deep rule of law oriented reforms. Such reforms can 
be encouraged and fostered by WTO compliance efforts, but except 
insofar as they support the development of domestic constituencies, 
they will contribute primarily at the margins. I am optimistic that 
there will be improvement over the medium term on these issues, but as 
a result of domestic trends that both pre-dated and go much deeper than China's WTO implementation.

II. CHINA'S ADHERENCE TO INTERNATIONAL STANDARDS IN THE WTO PROCESS IN 
                                 GENEVA

    The second issue I wish to address brings a different perspective 
to rule of law issues than has been addressed previously in this forum. 
This perspective examines China's activity in WTO in Geneva and at 
related international meetings, including the WTO Ministerial in Cancun 
2 weeks ago.
    Prior to China's becoming a member of the WTO, the question was 
often raised in Washington and elsewhere as to whether China would 
become a ``revisionist'' power in the WTO, attempting to change the 
rules and challenge the norms by which it operated. At that time, I 
argued that based on China's behavior in other multilateral economic 
institutions, China was unlikely to be a revisionist power but, rather, 
would in most cases ``play by the rules.'' \11\ Now that China has been 
a member for nearly 2 years, it is useful to evaluate its actual 
behavior in Geneva.
---------------------------------------------------------------------------
    \11\ Margaret M. Pearson, ``China's Track Record in the Global 
Economy,'' in China Business Review, 27:1 (January-February, 2000): 48-
53.
---------------------------------------------------------------------------
    Prior to engaging in an assessment, however, it is important 
highlight a distinction about the use of the term ``cooperation'' as 
applied to China's WTO behavior. We must be careful not to conflate the 
notion of ``cooperative behavior'' with ``adherence to the agenda of 
the United States.'' We may strongly prefer that China's agenda in the 
Doha Round decisions are aligned with those of the U.S. Government. But 
cooperative behavior in the WTO must be measured in terms of whether a 
country abides by the rules and norms established by the organization 
as a whole. In other words, does China adhere to the ``rules about 
rules'' of the organization? \12\ It is useful to keep in mind, for 
example, that some of the closest political allies of the United States 
may pursue agendas in some areas of the WTO that are quite inconsistent 
with our own. Hence, a huge number of disputes brought to the Dispute 
Resolution Mechanism in Geneva involving the United States also involve 
many close political and trading partners. At the level of day-to-day 
negotiations, then, ``cooperation'' cannot be defined by an absence of 
conflict with other nations, since conflict over trade interests is 
assumed and built into the process. Moreover, coalitions shift from 
issue to issue.
---------------------------------------------------------------------------
    \12\ A classic statement of this metric is Abram Chayes and Antonia 
Handler Chayes (1993), ``On Compliance,'' International Organization, 
Vol. 47, Issue 2 (Spring), pp. 175-205.
---------------------------------------------------------------------------
    In the PRC's first year of membership in WTO, we can conclude that 
it did not pursue a revisionist agenda.\13\ There are two major 
exceptions, discussed below, that cut at core issues of Chinese 
sovereignty. Yet the answer to whether China has been a ``cooperative'' 
power in the WTO is, by and large, ``yes.'' The Chinese delegation has 
made no effort to change the conservative consensus rules of the WTO. 
The informal processes to which the consensus rules give life are also 
accepted, notably the norm of non-interference in issues where a 
country's core interests are not involved. (In this, China's behavior 
can be contrasted with that of India.) China has welcomed the 
expectation of other countries, including the United States, that it 
should be--must be--an active participant in major WTO decisions, 
whether made formally or informally. China has made several moves to 
help give developing countries more voice, but except in the case of 
the meetings earlier this month in Cancun, these moves have not been 
particularly disruptive. And in all these moves China has been much 
more a follower than a leader.
---------------------------------------------------------------------------
    \13\ A longer version of this analysis, for the period up to June 
2003, is Margaret M. Pearson, ``China's Multiple Personalities in the 
WTO,'' in New Trends in the Study of Chinese Foreign Policy, edited by 
Alastair Iain Johnston and Robert Ross (manuscript pending review).
---------------------------------------------------------------------------
    China for the most part has not made its presence strongly felt in 
Geneva, moreover. The PRC delegation has spent considerable energy 
coming up to speed on the rules and norms of the organization, as well 
as on the TRM process, as discussed below. The delegation remains small 
and understaffed, and thus lacks capacity to pursue an aggressive 
agenda across. Moreover, domestic consultative arrangements have not 
been established to allow for the formulation of a cohesive trade 
policy, further hindering the ability to act aggressively within the 
WTO.
    Despite this overall pattern of cooperation, there are two issues 
on which China can be judged as conflicting fundamentally with WTO 
rules, norms, and expectations: Taiwan's membership, and the TRM. These 
issues are perceived in China as impinging on the PRC definition of a 
sovereign concern, and as a result China treats them in more rigidly 
category.
    Taiwan became a WTO member just following China's accession. The 
PRC's treatment of Taiwan's membership echoes its behavior in other 
multilateral institutions, although it is perhaps in some ways less 
rigid. At times members of the PRC delegation have been willing to meet 
informally with their Taiwanese counterparts (as in APEC, for example), 
and has dealt with the Taiwanese delegation in formal settings (such as 
responding to questions from Taiwan in the TRM context. More routinely, 
though, the PRC has broken the WTO norms for dealing with other 
members, notably using Chinese in communications rather than one of the 
official languages of the WTO, insisting on meeting in hotels rather 
than in the Geneva organization's buildings, and frequently refusing or 
canceling scheduled consultations on trade issues. The PRC delegation 
also has conflicted with the Taiwanese delegation with regard to issues 
of nomenclature and the status of the Taiwan mission. The effort is to 
ensure that reference to Taiwan's membership in the WTO not imply 
sovereignty for Taiwan. Most recently, in the spring of 2003, the WTO 
Director-General Supachai Panitchpakdi approached the head of the 
Taiwan delegation and, in essence, requested Taiwan to accept a 
downgrading of its status from ``permanent mission'' to ``office of 
permanent representative,'' and to affirm that the actions regarding 
WTO representation of Taiwan have no implications for sovereignty. The 
PRC appears to have been working through the lead agents of the WTO in 
an attempt to lend legitimacy to its pressure.
    The Transitional Review Mechanism (TRM) is a process established in 
China's accession protocol (and is unique to China) to review annually 
China's progress in implementation for the first 8 years of membership.\14\ The TRM is enormously unpopular in China. It is a focus point for PRC 
concerns about national humiliation and sovereignty, all the more 
aggravating because Chinese leaders agreed to submit to it. It also is 
evocative of the annual most favored Nation status debate in the U.S. 
Congress during the decade prior to China's WTO admission. However, 
unlike the MFN debate, China has a direct role in the TRM process and 
is therefore positioned to be much more defiant.
---------------------------------------------------------------------------
    \14\ All members are subject to a periodic ``Trade Policy Review `` 
(TPR) of their trading practices, a review that takes place within the 
Secretariat office. Reviews of China are not only more frequent than 
for other governments (compared for example to biannually for the U.S. 
and EU) but also involve multiple functional councils. This ``WTO-
plus'' commitment was established as a response to the fact that China 
was to be admitted prior to its full compliance with the terms of 
membership set for it. See Paragraph 18 of the accession protocol.
---------------------------------------------------------------------------
    It was in this context that the first TRM review occurred a year 
ago, in the fall of 2002. Under pressure particularly from the United 
States, discussion of problems with PRC compliance was initiated 
several months prior to the formal review scheduled to take place in 
December. The PRC's formal response was threefold: compliance issues 
should not be brought up significantly before the formal date of the 
review; China would respond to the issues raised, but only to the 
letter of the law and as such would only provide oral answers; and 
other discussions about compliance should take place in informal and/or 
bilateral settings. The debate was acrimonious. As China resisted 
giving full answers it became subject to much criticism. This left a 
bitter taste in the mouths of many in the foreign trade bureaucracy. It 
is likely that the PRC will explore ways to minimize the impact of the 
TRM in the current and coming years. I will come back to this point 
subsequently.
    With the exception of these two sovereignty-regarding situations, 
though, the PRC's behavior in Geneva cannot be judged to be revisionist 
or uncooperative. Indeed, U.S. officials were hopeful for cooperation 
on a range of issues. With regard to one major issue on the Doha 
agenda, agriculture, Chinese trade officials had expressed publicly and 
privately that cooperation with the US was quite possible on the 
proposal Ambassador Zoellick and Secretary Veneman put forward last 
year.
    It was thus contrary to expectation that China might join what is 
now known as the Group of 22 developing countries in putting forth a 
counterproposal to that of the EU and the United States at China's 
first ministerial meeting in Cancun earlier this month.\15\ In large 
part as a result of the stalemate between the two blocs, the meetings 
failed to produce an agreement on modalities for further agricultural 
negotiations. The main complaint of developing countries was that the 
working draft did not go far enough to commit to cuts in agricultural 
subsidies by developing countries, while at the same time asking for 
tariff reductions by (and with only a modicum of ``special and 
differential treatment'' for) developing countries. Developed countries 
have argued that the developing countries cannot expect the developed 
countries to make all the compromises, and that a breakdown in 
negotiations does not further the agenda of the developing countries, 
which need progress on agricultural negotiations more than the 
wealthier agricultural nations.
---------------------------------------------------------------------------
    \15\ The WTO's Fifth Ministerial Conference was held September 9-
14, 2003, in Cancun Mexico. The major substantive item on the agenda 
was decision on the framework for modalities for agriculture 
negotiations in the Doha Round. The working draft to be considered as 
the basis negotiations was the text submitted by the General Council 
chairman, Uruguay Ambassador Carlos Perez del Castillo. This draft was 
seen by the G22 as too close to the draft the United States and EU had 
agreed to several weeks earlier, and ignored concerns raised in a draft 
paper submitted in response by the group in August.
---------------------------------------------------------------------------
    While the internal PRC dynamic leading up to China's participation 
in the coalition is not yet fully clear, greater clarity can be shed on 
what occurred from the PRC point of view. China, which agreed in its 
own WTO accession agreement to lower tariffs, subsidies and supports 
than virtually any other country, is in the process of defining its own 
agricultural trade interests.\16\ The Chinese government is pinning 
increasing hopes on agricultural exports--primarily to its Asian 
neighbors that maintain high agricultural tariffs--to help ease rural 
poverty and unemployment. In this, it shares interests with the United 
States and Cairns Group, as well as a number of developing countries 
(but not India). It also has an interest in leveling the playing field 
in subsidies, which it claims it cannot afford. Its concrete interests 
therefore are split between a developing and developed country agenda.
---------------------------------------------------------------------------
    \16\ China agreed in its accession agreement to reduce average 
tariffs on agricultural imports to 15 percent by January 2004, to 
domestic supports of no greater than 8.5 percent, and a reduction of 
export subsidies to zero upon WTO entry. These agreements are 
summarized in Nicholas Lardy, Integrating China Into the World Economy 
(Brookings Press: 2002).
---------------------------------------------------------------------------
    How, then, should we assess China's membership in the Group of 22? 
First, China's willingness to join with developing countries on this 
issue is an important stand, and does lend weight to the developing 
agenda. Previous efforts to solidify a development agenda in 
agriculture did not get far, and China's entry into the fray is 
certainly part of the reason for the greater hearing to the development 
agenda in WTO. Having said that, China's role in this coalition was to 
lend support, but not to lead it or attempt, in rhetoric, to make the 
discussion more vituperative. The initiative for the coalition lay 
clearly with Brazil and India, notwithstanding the fact that China's 
name appeared routinely in articles on the coalition. Indeed, it has 
appeared quite aloof. China's delegation to Cancun, led by Minister of 
Commerce Lu Fuyuan, did not seek headlines. Lu's comments to the media 
conference where the G22 made its major statements were much more 
conciliatory than those of other participants, saying China ``hoped the 
Ministers would consider the G22 text even as they are considering the 
Chairman's draft'' (emphasis added). In contrast, for example, the 
Argentinean Minister said the paper ``must'' be accorded the same basis 
as the chair's text, while the Brazilian Foreign Minister stated that 
it was essential that the group's paper be taken as a basis for 
negotiations.\17\ As discussions among ministers were becoming 
particularly fractious, moreover, Lu intervened to point out that 
stalemate (which of course eventually occurred) was in nobody's 
interest.\18\
---------------------------------------------------------------------------
    \17\ Statements given at the September 8, 2003 media event are 
reported in Martin Khor, 
``Developing Countries Prepare for Agricultural Battle at Cancun 
Ministerial,'' TWN Report, September 9, 2003. The number of countries 
in the coalition changed over the course of the meetings from 20, to 
21, to 22--hence the differing monikers (G20, G21, and G22).
    \18\ Peter Wonacott and Neil King, ``China Moves Quietly to Push 
Trade Goals: Beijing, Balancing Needs to Its Farmers, Factories, Treads 
Softly at WTO Talks,'' Wall Street Journal, September 15, 2003.
---------------------------------------------------------------------------
    Moreover, China's media has barely reported the activities of China 
in the G22. The reports that have appeared have been descriptive and 
factual. No major analysis of the coalition and China's concrete role 
in Cancun has appeared in the press. No effort is being made to 
undermine the legitimacy of WTO processes, or to promote the idea that 
China is a developing country and working against the interests of the 
United States and EU.\19\ The key message is that China hopes to play a 
cooperative role in moving negotiations along in the future.
---------------------------------------------------------------------------
    \19\ See for example reports appearing at: www.people.com.cn/GB/
jingji/1037/2085439.html; www.chinanews.com.cn/n/2003-09-12/26/
345847.html; www.chinanews.com.cn/n/2003-09-04/26/342800.html; 
www.china.org.cn/chinese/EC-c/401659.htm; www.china.org.cn/chinese/
2003/Sep/403738.htm; finance.sina.com.cn/g/20030917/0753448722.shtml; 
PRC to Support Future WTO Talks; Promote Interests of Developing, New 
Member Nations,'' Xinhua (English), Sunday, September 14, 2003.
---------------------------------------------------------------------------
    China therefore has positioned itself, as in past statements in the 
WTO, to serve as a ``bridge'' between the developing and developed 
country agenda. Such behavior has more than a diplomatic function; it 
also allows China to maneuver in the future within the complex agenda, 
not having burned any bridges, to best meet its evolving view of its 
agricultural trade interests. Its doors are still open to diplomacy 
from all sides. In other words, it allows the government maximum 
flexibility in its ability to form coalitions. This is quite consistent 
with China's behavior across a range of multilateral institutions. In 
addition, there is a bilateral function to be served. Despite 
substantial bilateral tensions with India, both countries are trying to 
move ahead with international cooperation. Brazil and China, too, have 
made efforts to shore up their relationship in recent years. China's 
responsiveness to their initiatives is likely to have played a part in 
the PRC receptiveness to the coalition. Moreover, as China faces 
another TRM round in the fall, it can perhaps leverage its 
support for the cause of the developing world into support for its own 
efforts to shape the TRM process.
    Returning to the fundamental question of this portion of my 
testimony, while China's behavior was inconsistent with the position 
the United States took at Cancun, its actions were well within the 
scope of legitimate actions in the WTO--they did not breach dominant 
accepted norms. China's position reflects the complexity of the 
situation and its own evolving interests. Rather than closing the door 
to cooperation with any side, it remains open to conciliation.
                                 ______
                                 

                  Prepared Statement of Yasheng Huang

                           SEPTEMBER 24, 2003

    Thank you for giving me this opportunity to testify about an 
immensely important and complicated issue in the Sino-US relations as 
well as in the transition of China to a market-based economy.
    The topic of the hearing is, ``Is China playing by the rules? Free 
trade, fair trade, and WTO implementation.'' In my testimony, I will 
not address the question whether China is playing ``fair'' as I believe 
that fairness is an intrinsically subjective and political perspective. 
The first question in the fairness question is fairness to whom. If you 
hold the view that the cheap Chinese imports are ``unfair'' to those US 
firms producing the same products, one can equally argue that these 
imports are ``fair'' to those Americans who purchase these products. 
There are also American corporations which purchase imported 
intermediate products to manufacture their products. By this logic, 
those consumers who purchase America-made products that use imported 
intermediate products from China also benefit from cheap Chinese 
imports.
    As much as I can, I will stay away from this so-called ``fairness'' 
question because I respectfully submit that this question itself is 
poorly defined. What I want to do here is to provide an analytical 
perspective based on facts and evidence rather than getting into a more 
complicated issue as to whether China's trade and investment practices 
are fair or not. I am also testifying here in my capacity as a business 
school professor who analyzes business and economic trends in China 
rather than as a lawyer who follows the detailed legal and regulatory 
issues involved in the WTO implementation. What I want to do here is to 
provide some general backgrounds relating to the role of foreign direct 
investment (FDI) and foreign trade in the Chinese economy. My argument 
is that assessing China's accession and implementation of WTO against 
this general economic background can yield a very different conclusion 
from assessing China's WTO implementation against the specific 
provisions in China's accession document. I believe that China's WTO 
implementation should not be judged on narrowly legal grounds but on 
the broader economic and social grounds.
    There are three general points I want to make and emphasize in my 
testimony. First, China acceded to the WTO terms not as a closed 
economy but as a substantially open economy. In fact, by some measures, 
China is more open to FDI and foreign trade than the United States. 
This is a remarkable fact and we need to keep this in mind when we 
judge China's implementation record. Even if China were to have failed 
to implement each single provision of the WTO accession document, we 
cannot draw the conclusion that this is a closed economy designed to 
keep out foreigners. My second point is that while we can debate 
whether cheap Chinese imports are fair to Americans, we can 
legitimately make an argument that some of the Chinese regulations and 
practices are in fact unfair to the Chinese themselves, especially to 
the domestic private entrepreneurs, and the largest beneficiaries of 
unfair treatments are foreign firms; some are American firms.
    The third point is that the fact that China appears to be quite 
open to foreign trade and FDI is in part a result of some fundamental 
inefficiencies of its economic system. These inefficiencies suppress 
the investment and market potentials of truly domestic private firms, 
which are the most efficient firms in the Chinese economy. The effect 
of this suppression is that foreign firms have found more business 
space in China because they do not compete with the most efficient 
domestic private firms to the extent possible. An implication of this 
way of looking at the roles of foreign trade and FDI is that as some of 
these inefficiencies are being alleviated in the long run--5 to 10 
years--the importance of foreign trade and FDI may very well decline in 
the Chinese economy.\1\
---------------------------------------------------------------------------
    \1\ I have made this argument in greater detail elsewhere. See 
(Huang 2003).
---------------------------------------------------------------------------
    Let me organize my comments into three sections. The first section 
provides evidence to show that Chinese economy, even before the WTO 
accession, was already quite open and in fact, by some measures, more 
open to foreign trade and FDI than the United States. The second 
section explains this ``foreign'' bias in the Chinese economy--in favor 
of foreign firms and often to the detriment of domestic private firms. 
The third section provides some concluding remarks.

              THE UNUSUAL OPENNESS OF THE CHINESE ECONOMY

    By a number of conventional measures, China's economy in fact is 
quite open without the benefit of the WTO membership. On the trade 
side, a large portion of China's GDP is accounted for by foreign trade. 
Using official exchange rate conversion would yield a trade/GDP ratio 
of 40 percent, an extremely large share for a continental economy of 
China's size.\2\ For the US, the foreign trade/GDP was around 20 
percent in the 1990s. Japan had a similar ratio.
---------------------------------------------------------------------------
    \2\ Using the purchasing power parity conversion would yield a 
lower ratio, but the purchasing power parity measures are plagued by 
the uncertainty of exactly what constitutes the right purchasing power 
parity rate. If the ``true'' trade/GDP ratio is half of the ratio based 
on the official exchange rate, 20 percent of the GDP in foreign trade 
is still quite large. In comparison, the same ratio for Japan in 1998 
was about 20 percent and for the United States, it was 23 percent for 
1994.
---------------------------------------------------------------------------
    China is also quite open to foreign direct investment (FDI). Since 
the early 1990s China has been one of the largest FDI recipients in the 
world. In 1994, for example, China alone accounted for 49 percent of 
the total FDI flows to developing countries and 15 percent of the 
worldwide FDI flows. This ratio has declined in more recent years but 
China no doubt is the largest recipient of FDI among developing 
countries. For 2003, according to a number of estimates, China will 
surpass the United States in terms of the absolute level of FDI.
    Not only is the absolute size of FDI large, its relative size--
measured by FDI/capital formation ratio--surpassed that of many 
countries in the world (discussed below). I will also provide evidence 
to show that foreign-invested enterprises (FIEs)--i.e., joint ventures 
between Chinese and foreign firms or wholly owned foreign 
subsidiaries--have established a sizable presence in the Chinese 
economy and, in a number of industries, have come to command a dominant 
position.

                    FOREIGN VIS-A-VIS INTERNAL TRADE

    The outsized roles of foreign trade and FDI in Chinese economy are 
not only striking in comparing China with other countries but also in 
comparing China's dependency on external trade and on FDI with its 
patterns of internal, cross-provincial trade and investments. In a 1994 
report, the World Bank--the best study to date--noted that inter-
provincial trade normalized by provincial GDP was smaller than intra-
European trade.\3\ Transportation costs explain some of this but during 
the reform era inter-provincial trade has declined while there have been 
massive investments in roads, railways and airport facilities. This is 
a startling fact. Trade economists have long noticed a home bias in 
trade patterns, i.e., domestic residents tend to buy from each other 
much more than they do from foreigners. A study on the inter-provincial 
trade in Canada reveals that its internal trade about 20 times its 
trade with the 30 states in the United States--the states Canadian 
provinces traded with most intensively.\4\ Canada and the United States 
are two very similar countries on economic, political, and linguistic 
dimensions that should facilitate trade between them and yet internal 
trade in Canada still exceeds external trade by a wide margin.
---------------------------------------------------------------------------
    \3\ (World Bank 1994).
    \4\ The finding was reported in (McCallum 1995), as quoted in 
(Ghemawat 2000).
---------------------------------------------------------------------------
                      FDI/CAPITAL FORMATION RATIO

    A good relevant measure of China's openness to FDI is not the 
absolute size of FDI but FDI normalized by the size of the host 
economy. Countries vary in their economic and market size and the size 
of FDI flows ought to be gauged relative to the size of the host 
economy. The absolute size of FDI flows for the United States in 1990 
was much larger than the Chinese FDI but the US economy is roughly 
seven times as large (on the basis of official foreign exchange 
conversion). In that sense, the United States is less ``dependent'' on 
FDI than China is even though the absolute size of FDI flows into the 
United States is much greater.
    A common measure of the relative size of FDI is the ``FDI/capital 
formation ratio,'' given by the amount of FDI inflows in 1 year divided 
by the total fixed asset investments made by foreign and domestic firms 
in the same year. (In the paragraphs below, I use the term, FDI 
dependency, to refer to this ratio.)

  Table 1.--Measures of capital inflows: Foreign loans, actual foreign direct investment (FDI), and contractual
                                              alliances, 1979-1999
----------------------------------------------------------------------------------------------------------------
                           Amount (US$100 million)        Percentage shares of total     Actual FDI inflows as a
-------------------------------------------------------         capital inflows            percentage share of
                                                       --------------------------------  fixed asset investments
                                                                                              (percent)\2\
                                                                                       -------------------------
                        Foreign   Actual   Contractual            Actual                 Of Fixed-     Of Fixed
               Total     loans     FDI    alliances\1\  Foreign    FDI     Contractual     asset        asset
                                 inflows                 loans   inflows  alliances\1\  investments  investments
                                                                                           by all      by non-
                                                                                           firms     state firms
----------------------------------------------------------------------------------------------------------------
  1979-1982    124.57   106.90     11.66       6.01       85.82     9.36       4.82
       1983     19.81    10.65      6.36       2.80       53.76    32.10      14.13          0.88         2.63
       1984     27.05    12.86     12.58       1.61       47.54    46.51       5.95          1.60         4.52
       1985     46.45    26.88     16.61       2.96       57.87    35.76       6.37          1.92         5.65
       1986     72.57    50.14     18.74       3.69       69.09    25.82       5.08          2.07         6.21
       1987     84.52    58.05     23.14       3.33       68.68    27.38       3.94          2.27         6.41
       1988    102.27    64.87     31.94       5.46       63.43    31.23       5.34          2.50         6.86
       1989    100.59    62.86     33.92       3.81       62.49    33.72       3.79          2.90         7.97
       1990    102.89    65.34     34.87       2.68       63.50    33.89       2.60          3.69        10.90
       1991    115.55    68.88     43.66       3.01       59.61    37.78       2.60          4.15        12.36
       1992    192.03    79.11    110.07       2.85       41.20    57.32       1.48          7.51        23.52
       1993    389.60   111.89    275.15       2.56       28.72    70.62       0.66         12.13        30.81
       1994    432.13    92.67    337.67       1.79       21.44    78.14       0.41         17.08        39.18
       1995    481.33   103.27    375.21       2.85       21.46    77.95       0.59         15.65        34.35
       1996    548.04   126.69    417.26       4.09       23.12    76.14       0.75         15.10        31.81
       1997    587.51   120.21    452.57      14.73       20.46    77.03       2.51         15.04        31.66
       1998    579.36   110.00    454.63      14.72       18.99    78.47       2.54         13.25        28.27
       1999    526.60   102.12    403.19      15.18       19.40    76.60       2.88         11.20        24.10
       2000    594.50   100.00    407.10      17.71       16.80    68.50       2.98         10.30        20.60
       2001    496.80             468.80      18.40                94.40       3.70         10.50        19.50
       2002    550.10             527.40      21.30                95.90       3.87         10.10
----------------------------------------------------------------------------------------------------------------
Source: State Statistical Bureau, China Foreign Economic Statistical Yearbook 2000 (Beijing, China Statistics
  Press, 2000). Statistics for 2000, 2001 and 2002 are from http://www.moftec.gov.cn/moftec--cn/tjsj/wztj/wztj--
  menu.html and EIU.
Notes:
\1\ Contractual alliances refer to asset leasing, compensation trade, and product processing.
\2\ Fixed asset investments refer to purchases of new plants, property, and equipment made by both domestic and
  foreign firms in a given year. All the figures include investments made by FIEs.

    Column (3) of Table 1 presents three different measures of the 
relative FDI size during three periods in the 1980s, 1990s and the 
2001-2002 period. The three periods represent different phases of 
continuous FDI liberalization, as briefly summarized in the table. 
Column (3a) uses the fixed asset investments undertaken by all firms, 
including foreign firms, as the denominator. Column (3b) includes only 
the fixed asset investments by nonstate firms, that is, collective 
firms, FIEs, and domestic private firms. Column (3c) includes the fixed 
asset investments made by private firms and FIEs. One noticeable trend 
is the sharp rise in the FDI/capital formation ratio beginning in 1992. 
When we use the fixed asset investments undertaken by all firms, 
including FIEs, the ratio rose from 4.2 percent in 1991 to 7.5 percent 
in 1992. In 1994, the ratio reached 17.1 percent. Column (3b) shows a 
more rapid increase in the FDI/capital formation ratio when FDI is 
normalized by investments made by nonstate firms.
    State-owned enterprises (SOEs) account for a large portion of fixed 
asset investments. Since the investment activities of SOEs are heavily 
influenced by the government, it is more appropriate to compare the 
level of investment activities of foreign firms with that of nonstate 
domestic firms. Nonstate firms, including FIEs, are more market-driven 
and are subject to harder budget constraints compared with the SOEs. As 
the Hungarian economist Janos Kornai points out, SOEs are afflicted 
with an ``investment hunger'' and are prone to over-investing 
regardless of the market demand for their products (Kornai 1980). Thus, 
it is more meaningful analytically to compare the investment behavior 
of FIEs with other nonstate firms. Between 1993 and 1997, FDI accounted 
for over 30 percent of the fixed asset investments made by nonstate 
firms in each year and during the same period, on average, FDI 
accounted for about 53 percent of the fixed asset investments made by 
domestic private firms and FIEs. There is no question that FDI is a 
significant source of investment financing in China.
    Table 2 presents data on FDI/capital formation ratios in China and 
a number of other countries to provide a comparative perspective. The 
data are broken down by three periods, 1986-91, 1992-98, and 1999-2000. 
China's FDI dependency varied during these three periods. Compared with 
other countries in the table, it was initially low in the first period; 
it rose to a very high level in the second period; and it began to 
decline to a moderately high level in the third period.

                            Table 2.--Relative FDI Size, Macroeconomic Developments, and Business Environment, Various Years
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                   Annual average FDI flows/gross fixed                              Business environment for foreign
                                                    capital formation, all firms ratios                                          investors
                                                 (nonstate fixed asset investments only),     Gross     Current  ---------------------------------------
                                                                  percent                    domestic   account   Rank in terms    Business
                   Countries                   --------------------------------------------  savings    balance/    of ease of   environment  Corruption
                                                                                              rate,    GDP, 1994-    foreign     rank, 1996-  perception
                                                                                             1994-97       97     acquisitions,   2000 (out   rank, 1997
                                                  1986-91      1992-98        1999-2000     (percent)  (percent)   1996 (out of     of 60     (out of 52
                                                                                                                  46 countries)   countries)  countries)
--------------------------------------------------------------------------------------------------------------------------------------------------------
China.........................................    2.9 (8.6)  13.1 (27.9)       10.6 (21.5)       41.8        2.7          41            44          41
Philippines...................................    6.6 (8.1)   8.3 (10.2)         7.6 (9.4)       15.5       -8.5          40            35          40
Indonesia.....................................    2.3 (3.4)    5.4 (8.9)     -13.7 (-22.7)       33.5        0.0          37            46          46
Thailand......................................    5.5 (6.5)    5.6 (7.2)       11.9 (17.6)       38.0       -6.3          42            30          39
Malaysia......................................  14.7 (22.8)  16.9 (24.3)       22.1 (30.3)       40.0       -0.8          43            24          32
Taiwan........................................    3.6 (4.3)    2.2 (2.7)       11.8 (14.2)    \1\25.6    \1\-2.7          39            21          31
Korea.........................................    1.3 (1.6)    1.2 (2.0)        8.1 (10.7)       35.7       -1.8          46            29          34
Singapore.....................................  37.6 (49.7)  22.9 (30.3)         24.2 (32)       50.9       16.4          30             6           9
Brazil........................................    1.6 (2.1)    7.7 (9.0)       27.6 (33.9)       20.1       -0.8          29            38          36
Mexico........................................   8.3 (10.9)  13.5 (17.1)       10.7 (15.6)       21.4        0.5          28            34          47
India.........................................    0.3 (0.5)    2.2 (3.4)         2.1 (2.5)       21.2       -2.6          35            45          45
United States.................................    6.5 (7.7)    6.9 (8.1)       15.8 (18.3)       15.6       -1.6          19             1          16
Canada........................................    5.3 (6.1)   9.3 (10.6)       33.6 (38.6)       20.4        1.7          32             5           5
United Kingdom................................  13.6 (16.3)  13.5 (15.6)       41.9 (54.7)       14.7       -0.9          10             4          14
Russia........................................                 2.0 (2.2)        9.1 (10.5)       27.7        4.3          45            53          49
Poland........................................   0.01 (0.6)  13.1 (16.0)       20.6 (23.7)       16.7       -1.7          31            31          29
--------------------------------------------------------------------------------------------------------------------------------------------------------
Note: \1\ 1994 only.
Sources: FDI data are from United Nations Conference on Trade and Development (1998), United Nations Conference on Trade and Development (1999), United
  Nations Conference on Trade and Development (2000), and United Nations Conference on Trade and Development (2001). Private investment , savings and
  resource balance data are from the World Bank, World Development Report, various years and World Bank (1995a). For Taiwan, the source is Asian
  Development Bank (1995). The measure of ease of foreign acquisitions is based on a survey conducted by the International Institute for Management
  Development in Switzerland. Respondents were asked to rate countries according to a 10-point scale. A perfect score, 10, is given to countries that do
  not impose any restrictions on foreign acquisitions and 0 is given to countries where foreigners may not acquire control. The data are reported in
  International Institute for Management Development (1996). The business environment rank is a broader measure devised by the Economist Intelligence
  Unit. The country ranks for the 1996-2000 period are reported in ``Business Environment Scores and Ranks'' (2001). The corruption perception rank is
  devised by Transparency International; the 1997 data are reported on http://www.gwdg.de/?uwvw, accessed on October 23, 2001.

    Between 1992 and 1998, on average, FDI flows into China accounted 
for about 13 percent of the gross capital formation of all firms 
annually. This ratio is one of the highest among the countries in the 
table, even compared with countries traditionally considered to be very 
FDI-dependent, such as countries in Southeast Asia. As pointed out 
earlier, even though the United States attracted a greater amount of 
FDI, the relative importance of FDI in the United States, at 6.9 
percent during the 1992-98 period, was far smaller than it was in 
China. Compared with other Asian economies, China was less dependent on 
FDI in the 1980s, but its FDI 
dependency was among the highest in the region in the 1990s. China's 
FDI/capital formation ratio during the 1992-98 period was lower than 
that in Singapore and Malaysia, but much higher than that in Indonesia, 
Thailand, and the Philippines. The standard wisdom is that China is 
more similar to the Southeast Asian countries than it is to Korea, 
Taiwan, and Japan in terms of FDI dependency. That is true, but in fact 
China was among the most highly FDI-dependent economies in Asia during 
much of the 1990s. This is also the case if one uses gross domestic 
product (GDP), not fixed asset investment, to normalize FDI inflows.\5\ 
(China's FDI/GDP ratio is high whether one uses the official exchange 
rate or the purchasing power parity rate.\6\) The claim that China is 
highly dependent on FDI does not at all hinge on benchmarking China 
against traditionally small recipients of FDI, such as Japan and 
Korea.\7\
---------------------------------------------------------------------------
    \5\ (Urata 2001) presents the FDI inflow/GDP ratios for nine Asian 
economies (China, Hong Kong, Korea, Taiwan, Indonesia, Malaysia, 
Philippines, Singapore, and Thailand) between 1986 and 1997. From 1986 
to 1991, China ranked between No. 4 and No. 7 among these nine 
economies. From 1992 to 1997, China consistently ranked either as No. 2 
or No. 3 most dependent on FDI, behind Singapore and, sometimes, 
Malaysia. Take 1995 as an example. In that year, China's FDI/GDP ratio 
was 5.1 percent, compared to 2.2 percent for Indonesia, 2.0 percent for 
Philippines, and 1.2 percent for Thailand. (It was 4.8 percent for 
Malaysia and 8.5 percent for Singapore.) The choice of 1995 was not 
arbitrary. Because FDI flows can fluctuate more than GDP, I chose a 
medium ratio for China rather than either the highest or the lowest 
ratio. In 1993 and 1994, China's FDI/GDP ratio was high, at 6.4 percent 
and 6.2 percent, respectively, compared to 4.9 percent in 1997. The 
year 1997 probably should not be used as well because the Asian 
financial crisis might have adversely affected FDI flows into the 
Southeast Asian countries. The FDI/GDP ratios are from (Urata 2001).
    \6\ As is well known, purchasing power parity (PPP) exchange rates 
can vary from official exchange rates by a wide margin and, depending 
on which exchange rates are adopted, the FDI dependency ratios will 
differ dramatically. An additional source of complications is that 
extremely different purchasing power parity exchange rates exist. Even 
when a purchasing power parity rate on the high end is used, as in 
World Development Report 1996, China is still more dependent on FDI 
than many other countries, albeit at a smaller magnitude of difference. 
The FDI/PPP-based GNP ratio in 1994 was 0.78 percent for Asia as a 
whole and 0.81 percent for the industrial countries. At the same time, 
it was 1.13 percent for China, thus making China about as dependent on 
FDI as Canada (1.25 percent), France (1.46 percent), Australia (1.46 
percent), and Portugal (1.07 percent). It was more dependent on FDI 
than the United States (0.69 percent), Japan (0.03 percent), Italy 
(0.21 percent), and the United Kingdom (0.98 percent). These data are 
reported in (Li and Lian 1999).
    \7\ Other researchers have also noted China's high FDI dependency. 
Francoise Lemoine (2000), in a detailed descriptive analysis of China's 
FDI, makes the following remark, ``FDI capital stock represented 25 
percent of China's GDP in 1998, a ratio almost comparable to that 
existing in smaller economies which were opened to international 
capital flows long before China . . .'' Lemoine points out that on a 
per capita basis, China's FDI inflows appear to be low, compared to 
other Asian countries. In 1998, FDI stock per capita in China was only 
$160. This measure is highly questionable. On a per capita basis, China 
is low on many other fronts. To illustrate this point, by this measure, 
the war-torn Angola would be considered more attractive than China as 
an FDI host. In 1999, FDI stock per capita in that country was $537.
---------------------------------------------------------------------------
    China's FDI dependency, in a comparative perspective, is all the 
more striking if one takes into account the substantial investment 
roles of SOEs in China. As already pointed out, SOEs--subject to softer 
budget constraints compared to nonstate firms--are prone to over-
invest. It is reasonable to expect a country with substantial public 
sector investments to have a lower FDI/capital formation ratio. For 
this reason, China's high FDI/capital formation ratio--inclusive of 
investments by SOEs--compared with other countries with a far smaller 
public sector is powerful evidence of the substantial role of FDI in 
the Chinese economy. Another way to illustrate the same point is to 
derive a FDI/capital formation ratio net of investments by public 
sector entities. This is indicated by the bracketed numbers in column 
(1b) of Table 2. By this measure, China's FDI dependency was the second 
highest among all the countries represented in the table. During the 
1992-98 period China's FDI/capital formation ratio net of public sector 
investments was 27.9 percent, after Singapore (30.3 percent) but higher 
than Malaysia (24.3 percent).
    In the 1999-2000 period, that is, column (1c) of Table 1.2, China's 
FDI dependency declined compared with many countries in the table. A 
major factor was the rapid and sudden surge in FDI dependency among the 
advanced developed countries, such as the United States, the United 
Kingdom, and Canada, and developing countries, such as Brazil, Korea, 
and Thailand. It should be stressed that this 
sudden rise in FDI dependency constituted a substantial deviation from 
earlier dependency levels in these countries, suggesting that a number 
of country- and period-specific developments may have contributed to 
this outcome.\8\
---------------------------------------------------------------------------
    \8\ It is likely that the huge mergers and acquisitions in the 
``new economy'' sector of the advanced countries contributed to this 
rise in FDI dependency and that the financial crises in Korea, Brazil, 
and Thailand induced an increase in the type of FDI seeking 
opportunities related to financial distress in those economies. In 
Korea, for example, much of the FDI since 1998 went into the troubled 
financial industry. See (Huang and O'Neil-Massaro 2002). Of course, the 
financial crisis did not induce FDI in those countries where the crisis 
impaired political stability and economic growth prospects, as 
witnessed by the net outflow in Indonesia.
---------------------------------------------------------------------------
    What is also interesting is that since China's WTO accession, in 
2001 and 2002, FDI has continued to decline as a source of investment 
financing for the Chinese economy. FDI/capital formation ratio was 10.5 
percent in 2001 and 10.1 percent in 2002. This echoes the argument that 
I laid out at the very beginning of this statement, i.e., a very 
important reason for China's unusual openness to foreign trade and FDI 
is in fact a result of substantial inefficiencies of China's economic 
system. WTO accord and other policy measures implemented by the Chinese 
government since the late 1990s have alleviated some of these 
inefficiencies and therefore have actually reduced China's dependency 
on FDI. My own view is that in the long run the role of FDI is only 
going to decline in the Chinese economy as internal allocation of 
financial resources continues to improve.

               FDI VIS-A-VIS CROSS-PROVINCIAL INVESTMENTS

    I pointed out before that the Chinese trade with each other less 
than they trade with foreigners. There is also a similar investment 
dynamic here. Some Chinese provinces depend on FDI to a far greater 
extent than they do on each other as a source of investment funds. Take 
Guangdong province as an example. In 1992, Guangdong invested about 2.5 
percent of its total investments in other provinces while other 
provinces' investments amounted to 1.7 percent of total investments in 
Guangdong. In the same year, FDI accounted for 31.7 percent of 
Guangdong's investments, far surpassing both Guangdong's export of 
capital to other regions and its import of capital from other 
regions.\9\ In monetary terms, the 2.5 percent of outward investments 
in other provinces amounted to 399 million dollars. To put this number 
in perspective, in 1993, firms based in tiny Macao--known more for its 
casinos than its computers and for its gangs than for its garment 
making--invested 586.5 million dollars in China.\10\ (Unfortunately, 
the more recent data on cross-provincial investments are not available. 
The consensus is that internal trade and investments increased somewhat 
in the late 1990s but still they are at a lower level compared with 
China's foreign trade and FDI.)
---------------------------------------------------------------------------
    \9\ Guangdong's investment figure is calculated from Table 2.6, 
(World Bank 1994, p. 52).
    \10\ To clarify, China bans FDI in casinos and thus Macao's large 
investment position cannot be attributed to this source of its 
competitive advantage.
---------------------------------------------------------------------------
    This outsized investment position held by foreign firms is by no 
means limited to Guangdong, a province which has wooed foreign 
investments particularly aggressively. Sichuan, an interior province 
traditionally isolated from the outside world, also depended more 
heavily on FDI than on investments from other provinces. In 1993, 
investments from other provinces came to represent 0.22 percent of 
Sichuan's total investments; foreign investments, however, represented 
5.4 percent. The data compiled by the World Bank show that out of six 
provinces four on average relied more heavily on FDI than on 
investments from other provinces between 1985 and 1993. This is 
remarkable and it shows the outsized foreign investor position in the 
Chinese economy.
    The geographic dispersion of FDI is something that many people do 
not understand, including Chinese officials and Western economists. For 
example, in a presentation at a National Bureau of Economic Research 
conference, Zhang Shengman, a Chinese Ministry of Finance official and 
a managing director at the World Bank, argued that China ``must strive 
for a more desirable distribution of capital flows, both geographically 
(more to the interior) and sectorally (more to some service sectors, 
retailing, banking, insurance, etc.).'' \11\ Two researchers, Edward 
Graham and Erika Wada, in a study on FDI in China make the following 
observation, ``[V]ast areas of China, including ones where much state-
owned industry is located, have not been touched by FDI'' (Graham and 
Wada 2001, p. 5). In recent years, the Chinese government has made FDI 
promotion a prominent component of its development strategy for the 
central and western provinces.
---------------------------------------------------------------------------
    \11\ See (Zhang Shengman 1999), p. 181.
---------------------------------------------------------------------------
    The data that are often cited to support the geographic 
concentration hypothesis is that Eastern China accounted for 84.5 
percent of cumulative FDI between 1985 and 1991 and 87.3 percent 
between 1992 and 1998 (Gipouloux 2000). The problem with this view is 
that it relies on statistics on the percentage shares of FDI 
distributed among Chinese provinces. Recall, however, that during the 
1990s China attracted an enormous amount of FDI and thus a small 
portion of FDI going to the interior provinces is still a significant 
number. According to statistics provided in Gipouloux's study, the 
interior regions of China accounted for about 13 percent of cumulative 
FDI inflows between 1992 and 1998. During this period cumulative FDI 
flows into China as a whole amounted to $242.3 billion. This means that 
the interior regions of China received $31.5 billion in FDI. To put 
this number in perspective, India's entire FDI inward stock, as of 
1997, was only $11.2 billion. In addition, the poor, hinterland 
provinces of China absorbed either more than or about the same level of 
FDI as some of the star economies in Latin America in the 1990s. As of 
1997, the FDI inward stock for Argentina was $36 billion and it was 
$25.1 billion for Chile.\12\
---------------------------------------------------------------------------
    \12\ The data on India, Chile, and Argentina are provided in 
(United Nations Conference on Trade and Development 1998), Annex Table 
B.3.
---------------------------------------------------------------------------
    In 1995, the average FDI/capital formation ratio for 14 interior 
and western provinces was 4.9 percent; if investments by SOEs are 
excluded, the ratio was 14.9 percent.\13\ The 4.9 percent figure puts 
these provinces above Taiwan (2.2 percent), Korea (1.2 percent), India 
(2.2 percent), and Russia (2.0 percent). (All the numbers refer to the 
1992-98 period.) The 14.9 percent figure, that is, FDI normalized by 
investments of nonstate firms, would make China's interior and land-
locked provinces No. 6 out of the 15 economies represented in Table 2 
(excluding China). While she argues that the FDI distribution pattern 
in China is uneven, in her own paper, Lemoine (2000, p. 30) shows that 
FDI stock/GDP ratio for interior provinces was 10.9 percent in 1998. To 
put this number in perspective, in 1998, the FDI stock/GDP ratio for 
North America was 10.5 percent, for Central and Eastern Europe, 12.9 
percent, and for South, East and South-East Asia, 10.5 percent.\14\
---------------------------------------------------------------------------
    \13\ There are 16 provinces that are classified as interior or 
western provinces. No FDI data are available for two of these 
provinces--Inner Mongolia and Tibet. The remaining 14 provinces are: 
Shanxi, Anhui, Jiangxi, Henan, Hubei, Hunan, Sichuan, Guizhou, Yunnan, 
Shaanxi, Gansu, Qinghai, Ningxia, and Xinjiang. The figures are 
calculated on the basis of data provided in (State Statistical Bureau 
1996).
    \14\ These figures are from (United Nations Conference on Trade and 
Development 2000), Annex Table B. 5.
---------------------------------------------------------------------------
   THE UBIQUITOUS PRESENCE OF FOREIGN FIRMS ACROSS CHINESE INDUSTRIES

    FIEs, firms established through FDI, can be found in far more 
industries in than other countries. Empirical research on FDI has found 
that a general pattern of industry distribution of FDI is that FDI is 
concentrated in just a few industries. For example, in a survey article 
Newfarmer and March find that over 80 percent of foreign subsidiaries 
in Mexico and Brazil were in industries with four-firm concentration 
ratios exceeding 50 percent. Similar concentration patterns of foreign 
firms were found in Peru, Chile, Colombia, and Malaysia.\15\ According 
to Bruce Kogut, FDI in Central European countries exhibited a similar 
pattern. Foreign firms were found in only a few industries, such as 
autos, consumer products, and telecommunications. And the investing 
firms were familiar ones, such as ABB, Coca-Cola, and Proctor & 
Gamble.\16\
---------------------------------------------------------------------------
    \15\ This research is summarized in (Moran 1998, p. 23).
    \16\ Central Europe exhibits a familiar pattern of oligopolistic 
rivalry among foreign investors. FDI may disturb national oligopolies, 
although, as Kogut points out, multinational corporations prevail in 
industries characterized by oligopoly. See (Kogut 1996).
---------------------------------------------------------------------------
    FDI patterns in China are quite different in that FDI is present 
rather evenly across different industries. Data are available for FDI 
from Hong Kong broken down by industries for the 1990s for a number of 
countries on a consistent basis. These data show substantially less 
concentration patterns in China. For example, in Malaysia, the top 
three industries with the most Hong Kong FDI accounted for 58.9 percent 
of the total materialized Hong Kong FDI in 1994. In the same year, on 
an approval basis, the top three industries in Indonesia with the most 
Hong Kong FDI accounted for 77.6 percent of the total Hong Kong 
FDI.\17\ But in China, the top three industries, electronics, plastic 
products, and textiles, only accounted for 46.7 percent of total Hong 
Kong FDI as of 1993. The lower concentration ratio means that FDI is 
also present in many other industries in China. In fact among the 28 
manufacturing industries, none received more than 10 percent of total 
FDI as of the mid-1990s. The highest share was 9.6 percent in the 
electronics and telecommunications industry. The textile industry 
followed, at 8.9 percent.
---------------------------------------------------------------------------
    \17\ These data are calculated on the basis of Table 4.2 and Table 
4.3 in (Yeung 1998).) In the text, I use data from the 1970s because 
the industrial groupings are most similar to those in China, thus 
facilitating a direct comparison. The materialized amount may differ 
from the approval amount if an investor fails to invest the pledged 
amount of capital.
---------------------------------------------------------------------------
                  FOREIGN CONTROLS OF EXPORT MARKETING

    It follows naturally that the large FDI inflows would have led to a 
substantial role of FIEs in the Chinese economy. This is demonstrated 
in Table 3. As of 1995, FIEs controlled over half of China's 
manufactured exports, or 51.2 percent. Because FIEs are restricted in 
the primary industries and FIEs are not allowed to be pure trading 
corporations, their export share of total exports is smaller; in 1995, 
it was 31.5 percent.\18\ By 2002, FIEs accounted for over 50 percent of 
Chinese exports. Nationwide, FIEs dominate the export channels in a 
number of industries, such as electronics and telecommunications, 
garments and footwear, leather products, printing and record pressing, 
cultural products, and plastics, etc. In 1995, they accounted for over 
60 percent of Chinese exports in these industries.\19\ Nor are sales 
shares insignificant as well. In four industries, the sales shares of 
industrial FIEs exceeded 50 percent of industry sales and accounted for 
21 percent of all manufactured sales in 1995. This share grew to 32.1 
percent by 2000.\20\
---------------------------------------------------------------------------
    \18\ Export data for 1995 are from (State Statistical Bureau 1996). 
For some unknown reason, the Chinese government no longer released 
disaggregated FIE export data, broken down by economic sector or 
industry, after 1995.
    \19\ The source of data is Third Industrial Census. The firms 
covered by the Third Industrial Census are firms with an ``independent 
accounting system.'' This raises a number of data issues. See the 
appendix to this chapter for a detailed explanation of a number of data 
issues involved in using Third Industrial Census.
    \20\ Calculated from data provided in (State Statistical Bureau 
2001).
---------------------------------------------------------------------------
    Again, it is easier to illustrate the substantial role of FIEs in 
the Chinese economy by benchmarking China against other economies. FIEs 
in China have established a far more dominant position in export 
production than their counterparts in Taiwan, when Taiwan was in a 
comparable stage of development as China in the 1970s. As of the mid-
1970s, FIEs in Taiwan accounted for only 20 percent of Taiwan's 
manufactured exports.\21\ The share of FIEs in China's exports not only 
exceeds that of Taiwan but of other Asian countries as well during 
comparable stages of development. Two authors, Seiji Naya and Eric 
Ramstetter, provide some of the most complete statistics. Their paper 
shows that, except for Singapore, where multinational corporations 
(MNCs) have traditionally dominated domestic firms, no other Southeast 
Asian country came close to the 51 percent share of manufactured 
exports claimed by Chinese FIEs.\22\ In Korea, between 1974 and 1978, 
foreign firms accounted for 24.9 percent of manufactured exports. In 
Thailand, in the 1970s, the share ranged from 11 to 18 percent, and in 
1984 it was 5.8 percent.
---------------------------------------------------------------------------
    \21\ The export share data for Taiwan come from (Ranis and Schive 
1985).
    \22\ All the data on Korea and the Southeast Asian countries are 
from (Naya and Ramstetter 1988). Data for later years are more 
difficult to find, except for the export production data by FIEs in 
Indonesia cited in the text.

        Table 3.--Export Shares of FIEs in Total Exports of Three Economies: China, Taiwan, and Indonesia
                                                  (In percent)
----------------------------------------------------------------------------------------------------------------
                                             China (1995)            Taiwan (1980)           Indonesia (1995)
----------------------------------------------------------------------------------------------------------------
Labor-intensive industries...........  Garments and footwear:   Garments and footwear:   Garments and footwear:
                                        60.5.                    5.7.                     33
                                       Leather and fur          Leather and fur          Leather and related
                                        products: 73.2.          products: 9.6.           products: 19.7
                                       Furniture: 75.1........  Lumber and bamboo        Furniture: 14.0
                                                                 products: 2.7.
Capital or technology-intensive        Electronics and          Electronics and          Electric, measuring,
 industries.                            electrical appliances:   electrical appliances:   and photographic
                                        83.4.                    50.5.                    apparatus: 78.8
                                       Paper and paper          Pulp paper and paper     Computers and parts:
                                        products: 53.4.          products: 4.5.           91.8
                                       Chemical materials and   Chemicals: 34.9........  Machinery and vehicle
                                        products: 31.6.                                   parts: 86.1
                                         .....................    .....................  Paper and paper
                                                                                          products: 29.8
                                         .....................    .....................  Chemical materials:
                                                                                          42.3
Manufacturing industries.............  51.2...................  20.6...................  29.0
----------------------------------------------------------------------------------------------------------------
Sources: Chinese data are from Office of Third Industrial Census (1997) and Taiwanese data are from Ranis and
  Schive (1985, Table 2.12, p. 109). Indonesian data are unpublished and were provided to the author by the
  Indonesian government through the kind assistance of Timothy S. Buehrer and Lou Wells. Professor Lou Wells
  generously provided English translations of the Indonesian text.

    Table 3 presents FIE shares of total exports in three economies, 
China (1995), Taiwan (1980), and Indonesia (1995). The table breaks 
down export data by labor-intensive and capital- (or technology-) 
intensive industries. Two patterns emerge. One is that the FIE shares 
of exports in labor-intensive industries are much higher in China than 
in Taiwan or Indonesia. For example, garment and footwear FIEs 
accounted for 60.5 percent of exports in China, but only 5.7 percent in 
Taiwan and 33 percent in Indonesia. FIEs similarly dominated exports in 
leather and furniture in China to a far greater extent than they did in 
Taiwan and Indonesia. The second pattern is that in capital- or 
technology-intensive industries, FIEs in China and Indonesia dominated 
exports to a far greater extent than they did in Taiwan. This is a more 
common pattern in developing countries, not only because the local 
capabilities in modern industries are low, but because the goods being 
produced are intermediate inputs, such as electronic components. 
Japanese firms, for example, have invested heavily in Southeast Asia to 
produce electronic components, which are re-exported to the parent 
firms.\23\ Ownership arrangements are more common for this type of 
goods because often the only way for local producers to gain access to 
the supply chain of the MNCs is to be part of the MNC system. (In 
contrast, garments, footwear, and furniture are final goods or near 
final goods).
---------------------------------------------------------------------------
    \23\ A good discussion on this topic is found in (United Nations 
Conference on Trade and Development 1998), especially pp. 209-221.
---------------------------------------------------------------------------
                       FOREIGN CONTROL OF ASSETS

    The significant position of FIEs in the Chinese economy raises a 
natural question about control. Corporate control is a complicated 
concept but the simplest measure is the investor's share of the equity 
ownership. The higher the share, the more control the investor is said 
to have since equity ownership is usually an indicator of how 
decisionmaking power is apportioned among investors, through, for 
example, the number of board seats one can appoint. Since many FIEs in 
China are JVs, decisionmaking is shared among Chinese and foreign 
investors. The allocation of decisionmaking power is determined on the 
basis of their respective shares of equity ownership.
    Foreign firms have established majority controls over FIEs in most 
industries. Only in 7 out of 28 manufacturing industries are foreign 
firms found to have an average aggregate minority equity position, that 
is, the total equity value owned by the foreign firms is less than 50 
percent of the industry sum of FIE equity.\24\ State-owned monopolies 
or oligopolies are typically found in those industries where 
foreign firms have minority stakes. The tobacco industry is probably 
the most illustrative example. It is run by a single government agency, 
the China Monopoly 
Bureau of Tobacco Industry, which operates integrated production from 
tobacco procurement to cigarette making. But even in this heavily 
monopolistic industry, the combined equity stake of foreign firms 
already reached 46.9 percent by 1995. While foreign firms have been 
able to make inroads into industries explicitly reserved for the most 
powerful government corporations, nonstate indigenous firms have been 
largely excluded.
---------------------------------------------------------------------------
    \24\ Most of the industries, including the more capital-intensive 
industries, have a large number of enterprises. For example, there were 
1,409 FIEs in the transport equipment sector in 1995. The high foreign 
equity share is not the result of large equity positions of a few 
foreign firms.
---------------------------------------------------------------------------
    Another characteristic is that foreign majority equity controls 
seem unrelated to some of the well-known features of these industries. 
Foreign majority controls span both labor-intensive industries, such as 
garments, footwear, and leather products, and capital-intensive 
industries, such as chemicals, machinery, and instrument manufacturing. 
This across-the-board foreign equity control contrasts with the 
Taiwanese pattern. In Taiwan foreign firms have dominant equity 
positions in certain industries, such as garments and footwear (71.8 
percent), lumber and bamboo products (75.7 percent), and leather and 
fur products (79.6 percent). But in quite a number of industries, they 
are mere minority investors (such as nonmetallic minerals, chemicals, 
and the machinery industry).\25\ Thus, in China not only do foreign 
firms have larger equity positions and thus putatively greater 
corporate control over FIEs, their controls are uniform across 
industries.
---------------------------------------------------------------------------
    \25\ The Taiwanese data are reported in (Ranis and Schive 1985).
---------------------------------------------------------------------------
               WHY CHINESE ECONOMY IS ``UNUSUALLY'' OPEN?

    Chinese economy should be considered ``unusually'' open in two 
ways. First, it appears to be more dependent on foreign trade and FDI 
even compared with many market-oriented, developed economies. Second, 
Chinese economy is unusually open in that some sectors of the Chinese 
economy are more open to foreign investors than to domestic private 
businesses. In fact, one can go further by arguing that precisely 
because Chinese economy is quite closed to the domestic private sector 
it has become more open to foreign investors as a result. I have 
elaborated on this point in greater detail in my recently published 
book, Selling China (New York: Cambridge University Press, 2003). Let 
me explain this point here.

         CONSTITUTIONAL STATUS: FIES AND DOMESTIC PRIVATE FIRMS

    Western investors often view China's legal system as the single 
most important deterrent to FDI inflows. In 1997, a survey conducted by 
the European Commission of 200 European companies operating in China 
stated that ``incomprehensible or unpredictable rules and legislation 
remain the principal obstacle to investment in China.'' Looking 
forward, foreign investors are not very optimistic about the prospects 
of rule of law in China. In a 1997 survey on 22 foreign firms active in 
China, only 4 of them expected the rule of law to become widely 
accepted in China while most of the respondents viewed rule of law to 
be a goal of the government but not reality of the Chinese economy and 
society.\26\
---------------------------------------------------------------------------
    \26\ Quoted in (Lubman 1998).
---------------------------------------------------------------------------
    The usual question in the studies on government regulation is 
whether the regulatory environment is ``business-friendly.'' The answer 
to this question in the Chinese context is easy: It is not. The Wall 
Street Journal and Heritage Foundation rated China in 2002 as a 
``mostly unfree'' economy (given a bright yellow color to join the 
likes of India, Cambodia, Romania and Bulgaria) even after more than 20 
years of remarkable economic reforms. According to the aft-cited study, 
``China's legal and regulatory structure remains so riddled with 
contradictory internal (neibu) unpublished guidelines and exceptions 
that foreign businesses say progress in the rule of law has actually 
slowed in recent years.'' (The Heritage Foundation and The Wall Street 
Journal 2002)
    Many of these analyses, while not factually wrong, miss one of the 
most fundamental features of the Chinese economy. While it is widely 
recognized that Chinese legal system functions poorly, the relevant 
question is whether the Chinese legal system functions more poorly for 
some firms than for other firms. In particular, we want to know whether 
the legal system consistently favors one type of firms over others in 
accordance with the nationality of the firm. Here China is quite unique 
among many countries in that the government has created a legal 
framework that is on balance more favorable to foreign firms than to 
domestic private firms.
    On balance, the legal treatment of FIEs has been far superior than 
that accorded to domestic private firms (although inferior to that of 
state owned enterprises or SOEs). The most remarkable example concerns 
the constitutional treatment of FIEs and domestic private firms. 
China's Constitution, adopted in 1982, only 6 years after the Cultural 
Revolution, clarified and offered protection to the legal status of 
foreign enterprises operating in China (Article 18). Foreign 
enterprises were permitted ``to invest in China and to enter into 
various forms of economic cooperation with Chinese enterprises and 
other Chinese economic organizations . . .'' \27\ Article 18 also swore 
to protect their ``lawful rights and interests.''
---------------------------------------------------------------------------
    \27\ For an extensive analysis, see (Gelatt 1983).
---------------------------------------------------------------------------
    While Article 12 of the Constitution prohibited ``appropriation or 
damaging of State or collective property,'' no such a commitment was 
made about the property rights of private enterprises. Remarkably, more 
than 25 years after reforms began, the Constitutional treatment of 
domestic private firms remains inferior to that of foreign firms 
investing in China. The Chinese State has yet to make a Constitutional 
commitment not to nationalize or expropriate the assets of domestic 
private investors without ``due cause and compensation,'' the right 
foreign investors got in 1982.
    One example is the low political and legal status of private 
businesses. Article 11 of the 1982 Constitution acknowledged the 
property rights of self-employed private businesses--termed the 
individual economy--but it did not acknowledge the property rights of 
other types of private firms. In 1988, Article 11 was amended to add a 
clause that the State permitted private firms and that the State was to 
protect their ``lawful rights and interests,'' but the amendment also 
subordinated the private sector to ``a complement to the socialist 
public economy.'' \28\ This meant that private firms were allowed entry 
only in industries where they did not pose a competitive threat to the 
SOEs, but the strength of property rights protection provided to 
private businesses lagged far behind that for SOEs and even for FIEs.
---------------------------------------------------------------------------
    \28\ The text of the 1982 Constitution and the 1988 amendment is 
found in, Constitution of the People's Republic of China, (Beijing, 
Foreign Languages Press, 1994).
---------------------------------------------------------------------------
    In more recent years, the treatment of domestic private businesses 
began to improve. In March 1999, Article 11 was amended again and the 
private economy was to be a ``component'' of the Chinese economy. This 
meant, at least nominally, that private firms, FIEs, and SOEs were to 
have an equal status. In 2001, the former president of China, Jiang 
Zemin, welcomed private entrepreneurs to join the communist party. In 
2003, the Chinese officials were discussing a Constitutional 
amendment--to be adopted in 2004--that would specifically pledge 
protection of property rights to private businesses. (For texts of 
relevant clauses of China's Constitution, see Table 5.) \29\
---------------------------------------------------------------------------
    \29\ See Anonymous, ``Amendments to the Constitution of the 
People's Republic of China,'' Beijing Review, May 3-9, 1999.

 Table 5.--Evolving Constitutional provisions regarding private and foreign property rights in China, 1982-1999
----------------------------------------------------------------------------------------------------------------
                                         Adopted at the Fifth    The amendment adopted    The amendment adopted
                                         Session of the Fifth   at the Seventh National  at the third session of
      Constitutional provisions           National People's       People's Congress at      the Ninth National
                                        Congress, December 4,      its First Session,       People's Congress,
                                                 1982                April 12, 1988             March 1999
----------------------------------------------------------------------------------------------------------------
Article 11...........................  ``The individual         Article 11 of the        Article 11 of the
                                        economy of urban and     Constitution shall       Constitution is
                                        rural working people,    include a new            amended to: ``The non-
                                        operating within the     paragraph, which         public sector of the
                                        limits prescribed by     reads: ``The State       economy comprising
                                        law, is a complement     permits the private      self-employed and
                                        to the socialist         sector of the economy    private businesses
                                        public economy. The      to exist and develop     within the domain
                                        State protects the       within the limits        stipulated by law is
                                        lawful rights and        prescribed by law. The   an important component
                                        interests of the         private sector of the    of the country's
                                        individual economy..     economy is a             socialist market
                                                                 complement to the        economy.
                                                                 socialist public
                                                                 economy..
                                       The State guides,        The State protects the   The State protects the
                                        assists and supervises   lawful rights and        legitimate rights and
                                        the individual economy   interests of the         interests of the self-
                                        by administrative        private sector of the    employed and private
                                        control.''.              economy, and exercises   businesses. The State
                                                                 guidance, supervision    exercises guidance,
                                                                 and control over the     supervision and
                                                                 private sector of the    management over the
                                                                 economy.''.              self-employed and
                                                                                          private businesses.''
Article 18...........................  ``The People's Republic
                                        of China permits
                                        foreign enterprises,
                                        other foreign economic
                                        organizations and
                                        individual foreigners
                                        to invest in China and
                                        to enter into various
                                        forms of economic
                                        cooperation with
                                        Chinese enterprises
                                        and other Chinese
                                        economic organizations
                                        in accordance with the
                                        law of the People's
                                        Republic of China..
                                       All foreign
                                        enterprises, other
                                        foreign economic
                                        organizations as well
                                        as Chinese-foreign
                                        joint ventures within
                                        Chinese territory
                                        shall abide by the law
                                        of the People's
                                        Republic of China.
                                        Their lawful rights
                                        and interests are
                                        protected by the law
                                        of the People's
                                        Republic of China.''.
----------------------------------------------------------------------------------------------------------------
Source: Constitution of the People's Republic of China, Beijing, Foreign Languages Press, 1994 and ``Amendments
  to the Constitution of the People's Republic of China,'' (1999) Beijing Review, May 3-9.

                            FINANCIAL BIASES

    As China's pace of integration into the world economy accelerated, 
some influential economists in China argued that domestic private firms 
were often regarded as inferior compared to other firms in the Chinese 
economy. A 2000 report by the Chinese Academy of Social Sciences 
concluded the following:\30\
---------------------------------------------------------------------------
    \30\ Institute of Industrial Economics of Chinese Academy of Social 
Sciences, China's Industrial Development 2000, (Beijing: Economic 
Management Press, 2000).
---------------------------------------------------------------------------
    Because of long-standing prejudices and mistaken beliefs, private 
and individual enterprises have a lower political status and there are 
numerous policy and regulatory discrimination and limitations. The 
legal, policy, and market environment is unfair and inconsistent.
    For a long time, there was a severe lending bias against private 
firms in favor of the SOEs.\31\ Until 1998, the four big state-owned 
commercial banks, which controlled most of the banking assets, were 
specifically instructed to lend to SOEs only. (The Bank of China could 
lend to FIEs.) Lending to nonstate firms by the four commercial banks 
remained a minuscule portion of their loan portfolios. Among the 
nonstate firms, FIEs were able to access the Chinese banking system 
more readily than the domestic private firms. It should be pointed out, 
however, that the primary function of China's banking system is to 
serve the financial needs of the SOEs.
---------------------------------------------------------------------------
    \31\ The phenomenon of a lending bias on the part of the Chinese 
banking system in favor of SOEs was widely documented. See Ronald I. 
McKinnon, ``Financial growth and macroeconomic stability in China, 
1978-1992: Implications for Russia and other transitional economies,'' 
Journal of Comparative Economics, 18, 1994, pp. 438-469, and Nicholas 
R. Lardy, China's unfinished economic revolution, (Washington, DC, 
Brookings Institution, 1998).
---------------------------------------------------------------------------
    China's licensing policy also discriminated against private firms. 
In 2002, a top legislator, Tian Jiyun wrote in People's Daily that over 
60 industrial sectors were open to FDI but only 40 industrial sectors 
were open to investments by domestic private firms. Foreign trade 
licensing was also biased against domestic private firms. While the 
FIEs could directly export and import products within their business 
lines and many SOEs could export directly, until 1999, most private 
firms were required to export through the official state-owned trading 
corporations.

       EFFECTS OF DISCRIMINATION AGAINST DOMESTIC PRIVATE SECTOR

    One of the effects of discriminating against domestic private firms 
while maintaining a relatively open stance toward FDI is that foreign 
firms have managed to establish substantial market and industry 
positions, as documented in the previous section of this statement. In 
comparison, truly private firms--defined as those controlled by private 
entrepreneurs completely independent of the government--were still 
quite small. Excluding self-employed business units, truly private 
industrial firms only accounted for 9.2 percent of the value of the 
gross industrial output as of 2001. Industrial FIEs, in contrast, 
accounted for 28.5 percent.\32\
---------------------------------------------------------------------------
    \32\ Data are from the State Statistical Bureau, Zhongguo tongji 
nianjian 2002 [China Statistical Yearbook 2002], (Beijing, Zhongguo 
tongji chubanshe, 2002).
---------------------------------------------------------------------------
    A related effect is that the business environment, while admittedly 
difficult for many foreign firms in China, is in fact even more 
difficult for domestic private firms. We have a subjective measure--the 
perceptions of foreign and domestic firms of the constraints of China's 
business environment--to illustrate this point.
    Our perception data come from the World Business Environment Survey 
(WBES). The survey was implemented in 2000 and it focused on 
perceptions of factors external to the firm. Many dimensions of 
business environment were surveyed, ranging from perceptions of the 
national business environment as shaped by local economic policy; 
governance to the perceptions of regulatory, infrastructural and 
financial impediments and public service quality. The survey was done 
on roughly 100 firms in each of some 80 countries. For the first time, 
China agreed to be a part of this type of surveys.
    Very fortunately, the survey breaks down firms by their foreign and 
domestic ownership. Table 6 presents the average response scores given 
by foreign and domestic firms to a number of questions measuring 
regulatory burdens, rule of law, helpfulness of the government, and 
general business constraints. The minimum score is 1, indicating a good 
business environment perception; the maximum score ranges from 4 to 6, 
indicating a bad business environment perception. (The survey includes 
firms with ownership ties to the government. I have excluded them from 
Table 6 in order to demonstrate the contrast between FIEs and domestic 
private firms.)

   Table 6.--The average response scores given by foreign and domestic
          private firms on business environment in China, 2000
------------------------------------------------------------------------
                                                                Domestic
                                                     Foreign    private
                                                      firms      firms
------------------------------------------------------------------------
Business regulations: 1=no obstacle; 4=major             1.79       1.90
 obstacle.........................................
Labor regulations: 1=no obstacle; 4=major obstacle       1.62       1.70
General constraint--taxes and regulations: 1=no          1.86       2.17
 obstacle; 4=major obstacle.......................
Confidence in judicial system today: 1=fully             2.59       2.77
 agree; 6=fully disagree..........................
Quality of courts: 1=very good; 6=very bad........       3.15       2.97
Changes in laws and regulations: 1=completely            3.37       3.15
 predictable; 6=completely unpredictable..........
Helpfulness of central government today: 1=Very          3.00       3.02
 helpful; 5=Very unhelpful........................
Helpfulness of local government today: 1=Very            2.76       2.62
 helpful; 5=Very unhelpful........................
General constraint--financing: 1=no obstacle;            2.93       3.48
 4=major obstacle.................................
General constraint--corruption: 1=no obstacle;           1.93       2.13
 4=major obstacle.................................
------------------------------------------------------------------------
Source:World Bank Business Environment Survey.

    In some areas, domestic private firms feel more constrained than 
foreign firms; in other areas they feel less constrained. In general, 
domestic firms are constrained in the area of regulations. They gave a 
higher score for business and labor regulations and on general 
constraint on taxes and regulations. In general, foreign firms are less 
satisfied with China's legal system than domestic firms, although 
domestic firms appear to have less confidence than foreign firms in 
China's judicial system. Foreign and domestic private firms rate 
government similarly in terms of helpfulness of the government, 
although domestic private firms view local governments as more helpful. 
On the two critical measures of a business environment, financing and 
corruption, domestic private firms indicate more constraints than 
foreign firms and on the issue of financing constraint, substantially 
so.

                           CONCLUDING REMARKS

    Let me conclude by coming back to a point I made at the very 
beginning of this statement. China's WTO implementation is not a 
narrowly legal issue but should be judged against the general economic 
background of the country. Chinese economy is in fact ``unusually'' 
open to foreign firms not because it has very liberal FDI policies but 
because it has very illiberal policies toward the domestic private 
sector. A thorough WTO implementation may in fact help ease some of the 
constraints on domestic private sector and thus may contribute to a 
decline of the role of foreign trade and FDI in the Chinese economy. In 
fact, this is already happening since China's WTO accession as the 
government is trying to create a more equal playing field for foreign 
firms and for domestic private firms.

                         SELECTED BIBLIOGRAPHY

Asian Development Bank (1995). Key indicators of developing Asian and 
    Pacific countries. Manila: Oxford University Press.
``Business environment scores and ranks.'' (2001). Transition.
Constitution of the People's Republic of China (1994). Beijing: Foreign 
    Languages Press.
Gelatt, Timothy (1983). ``New Constitution Improves, Clarifies Legal 
    Position of Foreign Investors.'' East Asian Executive Report.
Ghemawat, Pankaj (2000). ``Economic evidence on the globalization of 
    markets.'' Boston: Harvard Business School Publishing.
Gipouloux, Francois (2000). ``Declining trend and uneven spatial 
    distribution of FDI in China.'' China Review 2000. C.M. Lau and J. 
    Shen. Hong Kong: The Chinese University Press: 285-305.
Graham, Edward M. and Erika Wada (2001). ``Foreign direct investment in 
    China: Effects on growth and economic performance.'' Canberra: 
    Australia National University.
Guangdong Statistical Bureau (2000). Guangdong Tongji Nianjian 2000 
    [Guangdong Statistical Yearbook 2000]. Beijing: Zhongguo tongji 
    chubanshe.
Huang, Yasheng (2003). Selling China: Foreign Direct Investment During 
    the Reform Era. New York: Cambridge University Press.
Huang, Yasheng and Kirsten J. O'Neil-Massaro (2002). ``Korea First Bank 
    (A).'' Boston: Harvard Business School.
International Institute for Management Development (1996). The World 
    Competitiveness Report 1996. Lausanne: IMD.
Kogut, Bruce (1996). ``Direct Investment, Experimentation, and 
    Corporate Governance in Transitional Economies.'' Corporate 
    Governance in Central Europe and Russia. R. Frydman, C.W. Gray and 
    A. Rapaczynski. Budapest: Central European Press. 1.
Kornai, Janos (1980). The economics of shortage. Amsterdam: North-
    Holland.
Lardy, Nicholas R. (1998). China's unfinished economic revolution. 
    Washington, DC: Brookings Institution.
Li, Shuhe and Peng Lian (1999). ``Governance and investment: Why can 
    China attract large-scale FDI despite its widespread corruption? '' 
    Hong Kong: City University of Hong Kong and Chinese University of 
    Hong Kong.
Lin, Cyril (2000). ``Corporate Governance of State-owned Enterprises in 
    China.'' Oxford: University of Oxford.
Lubman, Stanley B. (1998). ``The Legal and Policy Environment for 
    Foreign Direct Investment in China: Past Accomplishments, Future 
    Uncertainties.'' Private Investments Abroad. New York: Matthew 
    Bender & Co., Inc.
McCallum, John (1995). ``National borders matter: Canada-U.S. regional 
    trade patterns.'' American Economic Review. 85: 615-623.
McKinnon, Ronald I. (1994). ``Financial growth and macroeconomic 
    stability in China, 1978-1992: Implications for Russia and other 
    transitional economies.'' Journal of Comparative Economics 18: 438-
    469.
Moran, Theodore H. (1998). Foreign Direct Investment and Development. 
    Washington, DC: Institute for International Economics.
Naya, Seiji and Eric D. Ramstetter (1988). ``Policy interactions and 
    direct foreign investment in East and Southeast Asia.'' Journal of 
    World Trade. 22: 57-71.
Office of Third Industrial Census (1997). Zhonghua Renmin Gongheguo 
    1995 Nian Disanci Quanguo Pucha Ziliao Huibian [The Data of the 
    Third National Industrial Census of the People's Republic of China 
    in 1995]. Beijing: Zhongguo tongji chubanshe.
Ranis, Gustav and Chi Schive (1985). ``Direct Foreign Investment in 
    Taiwan.'' Foreign Trade and Investment. W. Galenson. Madison: 
    University of Wisconsin Press: 85-137.
So, Bennis Wai-yip (2000). ``China's private enterprises at the close 
    of the 1990s: Their growth and legal protection.'' China Review 
    2000. C.M. Lau and J. Shen. Hong Kong: The Chinese University 
    Press: 307-330.
State Statistical Bureau (1996). China regional economy: A profile of 
    17 years of reform and opening-up. Beijing: Zhongguo tongji 
    chubanshe.
State Statistical Bureau (1996). Zhongguo tongji nianjian 1996 [China 
    statistical yearbook 1996]. Beijing: Zhongguo tongji chubanshe.
State Statistical Bureau (1999). Zhongguo tongji nianjian 1999 [China 
    Statistical Yearbook 1999]. Beijing: Zhongguo tongji chubanshe.
State Statistical Bureau (2001). Zhongguo Tongji Nianjian 2001 [China 
    Statistical Yearbook 2001]. Beijing: Zhongguo tongji chubanshe.
The Heritage Foundation and The Wall Street Journal (2002). 2002 Index 
    of Economic Freedom. Washington, DC: The Heritage Foundation.
United Nations Conference on Trade and Development (1998). World 
    Investment Report 1998. New York.
United Nations Conference on Trade and Development (1999). World 
    Investment Report 1999. New York: United Nations.
United Nations Conference on Trade and Development (2000). World 
    Investment Report 2000. New York: United Nations.
Urata, Shujiro (2001). ``Emergence of an FDI-trade nexus and economic 
    growth in East Asia.'' Rethinking the East Asia Miracle. J.E. 
    Stiglitz and S. Yusuf. Oxford: Oxford University Press: 409-460.
World Bank (1994). China: Internal Market Development and Regulations. 
    Washington, DC: World Bank.
Yeung, Henry Wai-chung (1998). Transnational corporations and business 
    networks: Hong Kong firms in the ASEAN region. London: Routledge.
Zhang Shengman (1999). ``Capital flows to East Asia.'' International 
    capital flows. M. Feldstein. Chicago: University of Chicago Press: 
    177-181.
                                 ______
                                 

  Prepared Statement of Hon. James A. Leach, a U.S. Representative in 
  Congress From Iowa, Chairman, Congressional-Executive Commission on 
                                 China

                           SEPTEMBER 24, 2003

    This morning the Congressional-Executive Commission on China 
convenes to examine U.S.-China trade relations in the context of the 
development of the rule of law in China. We have asked our 
distinguished panelists to share their expert views with us on the 
Chinese trade policies that have a negative affect on U.S. businesses 
and whether or not the Chinese pursuit of such policies can be 
characterized as ``unfair'' under international norms and standards.
    The Chinese economy has experienced unprecedented growth in recent 
years. Between June 2002 and June 2003, Chinese exports grew by 32.6 
percent. Foreign direct investment into China grew to $52.7 billion in 
2002, pushing China past the United States and for the first time 
making it the number one target for foreign investment. While these 
growth trends began long before China's entry into the WTO in December 
2001, increased access to the largest consumer market in the world and 
sweeping market reforms will only increase China's attractiveness as a 
manufacturing base. Under these circumstances, China's robust growth 
may well continue for many years.
    But along with the benefits of WTO membership come 
responsibilities. The United States, together with all of China's 
trading partners, has been monitoring very carefully China's compliance 
with its obligations under the WTO accession protocol. In June 2002, 
the Commission held a hearing to look prospectively at China's ability 
to comply with its rule of law-related commitments. At that time, and 
according to the assessment of many experts throughout the first year 
of China's WTO membership, the consensus was that it was ``too early to 
tell'' whether China would be able to comply, and that China's 
performance in the second year after accession--when China had a chance 
to demonstrate its efforts to meet its obligations-would tell us more.
    As we near the end of ``Year 2,'' we ought to look again at how 
China is faring as a member of the international trading community. 
Measuring WTO compliance is one of the few empirical tools we have to 
assess the development of the rule of law in China: China's commitments 
to change its laws and policies are legally binding, and they have been 
embraced by the political leadership. Most trade experts agree that 
China has done very well in reducing tariffs, as required by the WTO 
terms of accession. Such explicit obligations are easier to meet, and 
China's trading partners may determine more easily whether or not China 
is in compliance with them.
    The WTO obligation to remove non-tariff barriers, however, is much 
harder to fulfill and also harder to assess. For example, indirect 
subsidization of protected industries may contravene WTO requirements. 
Also, failure to meet rule of law obligations, including transparency, 
equal application of the laws, the institution of judicial review, and 
national treatment for foreign goods and investors, may in effect 
operate as non-tariff barriers. Such barriers may unfairly protect 
domestic industries, and it may be that the United States should take 
specific steps to seek to break down these barriers. We must first, 
however, seek to understand the nature of these violations, and then we 
can determine the course the United States should take to seek redress. 
We hope today's testimony will help give us a sense of what the United 
States could and should ask China to do.
    One potential consequence of WTO noncompliance may be exacerbation 
of the U.S.-China bilateral trade deficit. The trade imbalance has 
become an issue of great concern to Americans in the past year, 
especially in communities dependent on manufacturing for economic 
survival. Although American concerns about the losses of the U.S. 
manufacturing base are legitimate, understanding what the bilateral 
deficit means and what its root causes are is crucial to finding the 
solution to the problems caused by the loss of manufacturing jobs. For 
this reason, we look forward to hearing testimony on how the United 
States should approach the U.S.-China trade imbalance.
    Some argue that China's undervaluation of its currency, the yuan, 
is a leading cause of the bilateral imbalance and also may be a 
violation of the WTO Subsidies Agreement. Others say that critics 
overstate the impact of the yuan's value, and that China's currency 
policy complies with its international obligations. Beyond the WTO, the 
Commission is keen to understand whether China's currency policies, or 
any other of its domestic policies, are ``unfair'' in the sense that 
they contravene the standards that China is reasonably expected to 
uphold as member or the international community and a partner in the 
international economic system.
    We look forward to hearing the views of our witnesses about how 
well China is complying with its WTO commitments, and whether China may 
or may not be 
conforming to other international standards and norms that may affect 
American businesses and the American economy. We hope all the panelists 
will recommend steps that the U.S. Government should take to address 
the outstanding issues in U.S.-China trade relations.
                                 ______
                                 

 Prepared Statement of Hon. Chuck Hagel, a U.S. Senator From Nebraska, 
        Co-Chairman, Congressional-Executive Commission on China

                           SEPTEMBER 24, 2003

    The U.S.-China relationship is the most important relationship our 
country will have over the next 50 years. Managing this relationship 
will be as complicated as it is critical. We must get it right.
    China's economic and political influence is growing, and few 
problems in the Asia-Pacific region can be solved without its 
cooperation. The United States and China are finding new ways to 
cooperate, from achieving stability in Northeast Asia, to intelligence 
sharing in the war against terrorism, to joint operations in battling 
international trafficking in narcotics. Despite this, we should not be 
surprised that we will continue to have serious differences with China. 
China must improve its human rights practices. It must improve its 
proliferation safeguards. And it must live up to its WTO commitments. 
Each of these issues, if left unresolved, will impact our overall 
relationship.
    China's current trade and economic policies demand close scrutiny 
because they impact both U.S. national security policy and U.S. jobs. 
Trade remains the biggest common denominator between our two countries 
and it offers the mutual benefits necessary to build a stable 
relationship for the future. However, U.S. exports to China have failed 
to keep pace with imports and it is in the best interests of both 
countries to adjust this imbalance. This will require China meeting its 
obligations for full, effective and uniform application of WTO 
commitments at the national, provincial, and local levels. China must 
also develop a reasonable timetable to achieve full convertibility of 
the yuan. The question of whether a currency is under or overvalued, 
and by how much, cannot be settled in the absence of a free market.
    China has undertaken many of its obligations under the WTO 
accession process, particularly in the area of tariff reductions. 
However, as the American Chamber of Commerce in China recently noted in 
its 2003 White Paper, ``the WTO honeymoon period is over.'' China is 
failing to implement its own laws protecting intellectual property 
rights. It has not taken the concrete regulatory steps necessary to 
open specific industries and sectors to competition. Progress on 
soybeans has been particularly troubling. U.S. exporters have faced 
Chinese government policies that are as unclear as they are 
complicated, and most recently U.S. soybean exports have been disrupted 
by non-science-based phytosanitary restrictions. China's efforts to 
meet its WTO commitments to implement tariff rate quotas for bulk 
agricultural products have been equally unsatisfactory. China must move 
forward in meeting each of these obligations.
    China understands that the political stability of Asia is closely 
linked to an expanding global economy, and this to the continued 
development of a fair and open trading system. China and the United 
States share this important goal. Building a cooperative agenda will 
not grow out of unrealistic expectations of what both sides can achieve 
in the short term, but instead out of the clear-eyed realization that 
we have a mutual interest in developing a common approach to a wide 
range of bilateral, regional and global issues in this new century. 
China's willingness to work with us in the coming weeks, months, and 
years will tell us much about whether China and the United States will 
move forward in building a deeper and more relevant relationship.
                                 ______
                                 

   Prepared Statement of Hon. Max Baucus, a U.S. Senator From Montana

                           SEPTEMBER 24, 2003

    Thank you, Chairman Leach and Co-Chairman Hagel, for holding this 
hearing. It comes at an important time.
    While the United States has lost millions of manufacturing jobs in 
the last few years, China's exports of manufactured products to the 
United States have soared. We're on track for the U.S. trade deficit 
with China to exceed $100 million for the second year in a row. In 
these circumstances, it is not surprising that a rising chorus of 
voices is demanding that something be done about China.
    One thing that we can do is to look carefully to make sure that 
China is properly implementing its WTO obligations. We are now 
approaching the end of the second year of China's WTO membership. This 
provides a good opportunity for us to take stock of how China is 
performing as a full member of the world trading system.
    It is my own sense that China has come a long way toward 
implementing the commitments it made in its WTO accession agreement, 
but it still has a long way to go. Problems that could have been 
chalked up to glitches or ``startup'' difficulties in the first year of 
China's WTO membership are now, in some cases, being seen as evidence 
of a lack of resolve on the part of the Chinese government to meet its 
obligations.

                      TRANSPARENCY IN REGULATIONS

    Perhaps chief among these is a widespread lack of transparency in 
licensing and permitting regulations, both in their drafting and their 
application. This makes it very difficult for U.S. companies to operate 
in China.
    Although China has passed many of the laws required under its WTO 
commitments, it has in many cases not issued any implementing 
regulations. This is true for various sectors of the economy, including 
the financial services, distribution, and automotive sectors.
    When regulations are issued, they are frequently issued without 
allowing sufficient time for industry participants to comment. And they 
often impose barriers, such as excess capitalization requirements, that 
appear designed to discourage foreign businesses from entering the 
market at all.

                           TARIFF RATE QUOTAS

    Another problem of great concern to me deals with China's failure 
to allocate its tariff rate quotas (``TRQs'') for agricultural products 
in accordance with its accession agreement. China has allocated 
uneconomic amounts to some quota recipients. It also does not disclose 
the identity of those receiving allotments as it had agreed to do. This 
makes it difficult for U.S. companies to identify potential customers. 
Further, import permits are effectively being used to maintain import 
controls on U.S. agriculture commodities and meat exports, important 
products for my home State of Montana.
    This is a longstanding problem. In July, I urged USTR to begin 
preparing a WTO case on Chinese TRQs. Since then, I have been told that 
there may have been some movement toward a resolution on this issue. I 
hope the witnesses can inform us about any progress on China's TRQs.

                         INTELLECTUAL PROPERTY

    China's attitude toward intellectual property is also great cause 
for concern. Counterfeiting of U.S. trademarks is rampant. Copyright 
piracy is a thriving industry in China. The piracy rate for movies, 
video games, and music approaches 90 percent. This is clearly 
unacceptable. China needs to do more to protect intellectual property.
    I am also concerned about regulations China is currently developing 
for a government procurement law China enacted earlier this year. Those 
regulations would require the government to purchase only domestic 
goods and services, including software.

                            VALUE-ADDED TAX

    Another issue deals with China's value-added tax (''VAT''). In some 
cases, China applies its VAT to discriminate against imports. Officials 
may exempt locally produced goods while assessing the full VAT on 
imported goods, or they may rebate the VAT on goods made and sold in 
China.

                                CURRENCY

    The final issue I want to raise deals with China's currency. China 
pegs its currency at a fixed exchange rate that economists estimate is 
undervalued by anywhere between 15 to 40 percent against the U.S. 
dollar. This artificially depresses the prices of Chinese exports and 
hurts the competitiveness of U.S. manufacturers.
    When I was in Cancun a few weeks ago for the WTO ministerial, I had 
the opportunity to discuss this issue with Chinese Commerce Minister Lu 
Fuyuan. Minister Lu made clear that China appreciates the need to 
revalue its currency for its own internal reasons, but he added that 
this won't happen for several years.
    We should continue to impress upon the Chinese the many reasons why 
it should allow the value of its currency to be determined according to 
market principles. As an interim step, China should immediately revalue 
its currency significantly or begin to set its exchange rate values in 
reference to a basket of foreign currencies--rather than simply pegging 
it to the dollar. This is an issue that I will continue to follow very 
closely.

                               CONCLUSION

    I've chosen to highlight just a few of the problems in China's WTO 
compliance and trade with the United States. There are others.
    I hope the witnesses will discuss these issues in their testimony. 
In particular, I hope they will address what steps the United States 
has taken or plans to take to respond to these concerns.
    I worked hard to ensure China's accession to the WTO, and I will 
work hard to ensure that China abides by its WTO commitments. I look 
forward to working with my colleagues and the Administration to make 
sure that China plays by the rules. Thank you.
                                 ______
                                 

   Prepared Statement of Hon. Marcy Kaptur, a U.S. Representative in 
                           Congress From Ohio

                           SEPTEMBER 24, 2003

    Mr. Chairman, I am pleased that the Commission is meeting today to 
discuss our trade relations with China. As an original member of this 
Commission, I believe it is vital that we look at the record trade 
deficits we have with our number one trading partner.
    First, as I examine the list of panelists, I must express some 
concern about its makeup. There is plenty of representation for the 
Administration, Big Business, and academia. Unfortunately, one of the 
most essential voices has been silenced--that of the workers. There is 
no representation of the working men and women from the United States 
or China. We hardly can understand the full spectrum of issues related 
to trade relations without hearing from the people on the factory floor 
or those who work in the fields. To ignore this is inexcusable.
    The Commission should ensure that we always start with the facts. 
One of the most noteworthy details is our escalating trade deficit with 
China. Mr. Chairman, I ask that the following be inserted into the 
record:

                           China Trade Deficit
                              (In billions)



1999 (Before PNTR).........................................       -$68
2000 (PNTR passed in May)..................................        -83
2001.......................................................        -83
22002......................................................       -103
2003 (Through May).........................................        -65


    When I began my career in Congress, the discussion was much the 
same--only we were speaking about Japan. Record trade deficits, 
questions about currency valuation and market access were the hot 
topics. Little has changed 21 years later. Several administrations and 
legislative proposals later, little has changed because Japan is not a 
free market. It is a managed market. We have tried to open the Japanese 
market. In 1983, less than 3 percent of Japan's market consisted of 
automobiles or auto parts from international sources. In 2003, it is 
the same. It does not matter if it is 150 yen to the dollar or 98.
    What makes us think that China is any different? It too is a 
managed market. The only way we will be able to measure success is 
through the trade deficit. Are we buying more or selling more?
    Over the last decade, the U.S. has lost millions of manufacturing 
jobs. Fifty cents of every U.S. farm dollar comes from Federal 
subsidies. Something is fundamentally wrong with the trade accounts and 
it is evident at the highest policy levels. The United States is 
essentially cashing out its wealth.
    One such wealth is the job of the working American. I call on the 
various departments who are supposed to be overseeing our trade 
policy--United States Office of the Trade Representative, Department of 
Commerce, and the Department of Labor--to invest some of their 
resources in workers here and in China. Let us as a Commission, as 
Members of Congress, travel to China to see what is really going on.
    In my area of the country, Huffy Bicycle had 2,000 people employed 
in Ohio manufacturing the best bicycles in America. All of those 
workers have now lost their jobs. They were earning a living wage. They 
had health benefits. They produced a fine product.
    Those Huffy bicycles are now made in China. This Commission should 
visit that factory. The Administration should travel with us to see the 
working conditions. Instead of a living wage they earn starvation 
wages. I cannot imagine the type of ``health plan'' with which the 
Chinese workers were presented.
    The expatriate companies are trading on the exploitation of 
workers. They are trading on environmental conditions where they are 
leaving cesspools around the earth. Until we challenge that, the U.S. 
will never balance these trade accounts. It is well-known that these 
imbalances are not sustainable. We need to be realistic and, in turn, 
create a realistic trade plan.
    I encourage the USTR and the Departments of Commerce and Labor to 
set a target of reducing our trade deficit. I am not going to suggest 
that we turn a deficit into a surplus overnight. However, we must stem 
this tide of record trade deficits. Simply working toward a lower level 
this year than last would be a step in the right direction. This is not 
an unattainable task. It is one upon which our economic future depends 
and the least the Administration could do for working families.
                                 ______
                                 

 Prepared Statement of Hon. Sander M. Levin, a U.S. Representative in 
                         Congress From Michigan

                           SEPTEMBER 24, 2003

    Today's hearing is called, ``Is China Playing by the Rules? '' The 
answer to that question is clearly and unfortunately, ``No.'' China has 
not yet come into full compliance with its WTO commitments. I am not 
talking about the commitments that China's WTO agreement allows it to 
phase in; I am speaking of the commitments China agreed to fully 
implement either immediately or within its first 2 years of WTO 
accession. China has not yet fulfilled many of these commitments; in 
other cases, China has taken steps that indicate a clear intention to 
undermine its WTO market access commitments.
    In many areas, China has made substantial progress and it is 
important to acknowledge that progress. At the same time, halting 
progress is not what the U.S. bargained so hard for. The United States 
is fully living up to its WTO commitments vis-a-vis China--evidenced by 
total Chinese imports to the United States of $125 billion. The massive 
trade deficit with China of over $100 billion--the single largest U.S. 
bilateral trade deficit--reminds us that we cannot be satisfied with 
mere ``progress'' from China. We need complete, unconditional, and 
timely compliance from China with its WTO commitments.
    Last year, many in Congress, the business community and the 
Administration were willing to take a ``pressure and patience'' 
approach, giving China time to make all the myriad changes to law and 
practice necessitated by WTO accession. Indeed, we still must realize 
the massive restructuring that China's legal system, even China's 
society, is undergoing by virtue of China's membership in the WTO. Had 
China made concerted, uninterrupted, and steady progress toward WTO 
compliance, that approach may have continued.
    Unfortunately, the Chinese government's lack of attention to the 
rule of law has infected its approach to WTO compliance. The Chinese 
government has often taken arbitrary and inconsistent approaches to its 
WTO obligations; it has acted in non-transparent ways and refused to 
publish the laws and regulations with which businesses must comply; in 
some cases, the Chinese government has retained for itself a large 
measure of discretion, creating an uncertain environment and leaving 
companies unclear as to what the rules are.
    Moreover, China has blocked effective use of the specially 
negotiated annual Transitional Review Mechanism (TRM) of China's WTO 
compliance. In most cases, China has refused to provide written answers 
to questions submitted by other WTO Members; in many other cases China 
has refused to provide any answers or given vague and evasive answers. 
China has denied consensus on efforts to make the TRM process more 
effective and has even gone so far as to call countries that raised 
concerns about China's WTO compliance ``troublemakers,'' reminiscent of 
language China uses in the domestic context to silence dissent.
    Listed below are just some of the continuing problems with China's 
WTO accession:

 Transparency.--Article X of the WTO requires countries to 
    publish in advance all laws, regulations, etc. affecting the 
    import, sale, distribution, transportation, insurance, warehousing, 
    inspection, etc. of imports. China has made some progress, but 
    still does not uniformly publish laws and regulations applicable to 
    trade, meaning U.S. firms often do not know what the rules are, 
    whether the rules have changed, or how to comply with the rules.
 Additionally, even when China does publish regulations, these 
    are often very vague and leave government authorities wide 
    discretion, which is applied in an unpredictable manner and in ways 
    preferential to Chinese-based manufacturers.
 Quota Administration and Import Licensing.--China's 
    administration of its quotas and import licensing rules has made it 
    very difficult for companies in China to import products from the 
    United States and for U.S. exporters to find Chinese buyers. For 
    instance, China announced increases in quotas on automobiles and 
    auto parts, but there is little public information on what 
    companies received quota allocations or how those quotas may be 
    exercised. In some cases, allegations have arisen that China has 
    awarded import quotas in economically unviable amounts, to domestic 
    producers of competing products or state-owned companies that have 
    no intention of importing, and to companies that have committed to 
    use the import only as an input for products to exported.
 Discriminatory taxes.--China continues to impose 
    discriminatory taxing schemes on various ``border trade'' products 
    and other products, including integrated circuit products. The 
    former clearly violates MFN and the latter clearly violates China's 
    national treatment obligations.
 Continuing Limits on Trading Rights.--China only allows some 
    companies to import and export products (``trading rights''). China 
    strictly controls which companies have such rights, and uses this 
    control as a tool to restrict imports. China agreed to broaden 
    trading rights, but it has not yet implemented its commitments and 
    appears to be imposing new conditions on these rights.
 Distribution Rights.--Even if U.S. products are imported via 
    trading rights, China imposes limits on who may distribute 
    products. China uses these distribution rights as a way of keeping 
    out U.S. imports. China is obligated by its WTO commitments to 
    expand distribution rights, but has failed to take all the steps 
    necessary to do this.
 Intellectual Property.--Intellectual property piracy is 
    rampant throughout China. China has made progress to improve its 
    legal framework, but continues to have a poor record of 
    enforcement, suggesting a lack of will from the government.
 Technical Barriers to Imports.--In some sectors China has 
    issued new technical product and safety regulations that are sui 
    generis and appear to be designed to help keep out imports.
 Currency Undervaluation.--Article XV(4) of the GATT prohibits 
    WTO members from using ``exchange action'' to ``frustrate the 
    intent of the [GATT] provisions.'' China has allowed kept its 
    currency pegged to the dollar at a rate that economists agree is 
    substantially undervalued, effectively providing a ``currency 
    tariff'' on U.S. exports to China and a ``currency subsidy'' to 
    Chinese imports to the United States.
 Auto Financing and Other Financial Services Limited by 
    Unreasonably High Capital Requirements.--China agreed to open its 
    auto financing market to U.S. firms upon its WTO accession. China 
    has not complied with this obligation 2 years later. Its draft 
    regulations contained unreasonably high capital requirements that 
    are not justified by any prudential or regulatory rationale and it 
    has yet to issue final regulations. Other U.S. financial services 
    providers face similar market access barriers.
 Auto Industrial Policy Paper.--In April of this year, China 
    issued a draft ``Development Policy for Auto Industry'' setting 
    forth Chinese government industrial policy for the automotive 
    industry. This paper is admittedly light on specifics, but the 
    following concepts in the paper are or could be problematic:

        --Mentions ``macroeconomic steering'' to achieve the objective 
        of becoming ``one of the major automobile manufacturing 
        countries in the world by 2010.''
        --Indicates numerous points in which the state will standard-
        less control over competitive decisions of automobile 
        manufacturers in China through various approval mechanisms, 
        which could be used as way of forcing technology transfer or 
        limiting allowable imports.
        --Includes plans to restrict the number of ports through which 
        imported autos may enter.
        --Requires that imported and domestically produced autos be 
        distributed through separate sales outlets.
        --Sets export targets of components and parts of 40 percent by 
        2010.
        --Suggests that technical requirements will be used as a way of 
        keeping out imports and simple assembly operations.
        --Indicates that the state will provide subsidies for the 
        development of auto electronics.
        --Dangles for foreign firms the possibility of a ``strategic 
        alliance'' with a domestic firm that would have 10 percent 
        market share in exchange for technology and know-how transfer.
        --Suggests availability of state-subsidized capital for the 
        domestic auto industry.
        --Indicates firms will have to produce domestically in China at 
        least 5 years before they can enter new product lines or open 
        new factories in other cities.
        --Indicates that preferential treatment will be given to plants 
        set up for export.
        --Indicates that state subsidies will be provided to develop 
        stronger domestic steel plate for autos manufacturing capacity 
        and machine tools and dies.
        --Sets goal that Chinese companies will provide designs for 
        half of all domestically produced cars by 2010.
        --Indicates that quotas and creative application of customs 
        duties will be used to keep out auto part imports.

    Compliance with WTO obligations cannot be a one-way street. It is 
time for the USTR to take the lead and aggressively demand China's 
complete, unconditional, and timely compliance with all of its WTO 
commitments. USTR must use every avenue to push China to come into 
compliance with its WTO obligations. Last year, the USTR allowed China 
to block effective use of the TRM, and it looks as if this year, USTR 
is resigned to accept continuing uncooperativeness by China as a fact 
of life. The TRM was designed to help avoid larger confrontations over 
China's WTO compliance. If China continues to defy the WTO and 
frustrate the TRM process, USTR should begin a campaign of cases 
against China in WTO dispute settlement.
    American manufacturers are justifiably concerned that Chinese 
imports have free access to our market, while China has refused to open 
its market more fully to U.S. goods. It is time to start taking 
concrete action to remedy the imbalance.

