International Trade: Challenges and Opportunities for U.S. Businesses in
China (Testimony, 07/29/96, GAO/T-NSIAD-96-214).

GAO discussed the challenges and opportunities for U.S. businesses in
China. GAO noted that: (1) energy production, transportation,
telecommunications, and the environment are key sectors for U.S. exports
to China; (2) impediments to accessing the Chinese market include poor
intellectual property protections, and the failure to implement
international trade standards; (3) China and the United States are
conducting negotiations and establishing memoranda of understanding on
these issues, but many improvements have come only in response to U.S.
threats and punitive actions; (4) many U.S. businesses in China believe
that China's admission into the World Trade Organization (WTO) should
depend on China significantly liberalizing its markets; (5) academic
experts believe that China needs to improve its basic institutional
infrastructure whether its admitted to WTO or not; (6) China has been
the largest recipient of World Bank loan commitments in the 1990s and
China is using the Bank's services and assistance to reform its economy;
(7) to promote market-oriented reforms, the Bank is emphasizing
competition, helping government staff develop managerial expertise in
competitive bidding practices, project appraisal, and project evaluation
methods, and introducing financial analysis techniques and methods; (8)
the Bank is also helping reform the Chinese financial sector by moving
it from government control and allowing increased participation of
foreign financial institutions under certain conditions; and (9) China
will need to make further improvements if it is to sustain economic
growth and stability.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  T-NSIAD-96-214
     TITLE:  International Trade: Challenges and Opportunities for U.S. 
             Businesses in China
      DATE:  07/29/96
   SUBJECT:  Business assistance
             Economic growth
             Foreign governments
             Restrictive trade practices
             Foreign policies
             International economic relations
             International trade regulation
             Foreign trade agreements
             International cooperation
IDENTIFIER:  China
             Beijing (China)
             Shanghai (China)
             Shenzhen (China)
             Dalian (China)
             Jiangsu (China)
             
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Cover
================================================================ COVER


Before the Committee on Banking and Financial Services,
House of Representatives

For Release on Delivery
Expected at
1:00 p.m., EDT
Monday,
July 29, 1996

INTERNATIONAL TRADE
- CHALLENGES AND OPPORTUNITIES FOR
U.S.  BUSINESSES IN CHINA

Statement of JayEtta Z.  Hecker, Associate Director,
International Relations and Trade Issues, National Security and
International Affairs Division

GAO/T-NSIAD-96-214

GAO/NSIAD-96-214T


(711220)


Abbreviations
=============================================================== ABBREV

  FDI - foreign direct investment
  GNP - gross national product
  IDA - International Development Association
  IPR - intellectual property rights
  MOU - memorandum of understanding
  USTR - U.S.  Trade Representatives
  WTO - World Trade Organization

============================================================ Chapter 0

Mr.  Chairman and Members of the Committee: 

I am pleased to be here today to discuss some of the challenges and
opportunities for U.S.  businesses in China.  My statement is based
upon what we have observed as a result of completed and ongoing work
addressing various issues regarding U.S.-China trade and economic
relations.  As you know, after 15 years of economic reform, the
Chinese economy has become one of the fastest-growing in the world. 
However, while China has moved toward a quasi-market system,
significant trade barriers still exist, according to U.S.  businesses
and the office of the U.S.  Trade Representative (USTR).  While
managing to liberalize its economy and maintain rapid growth, the
Chinese government has not yet fully implemented fundamental
standards for international commerce.  Despite gains that have been
made in certain sectors, U.S.  businesses still face a wide array of
challenges in obtaining access to the China market.  My statement
today will cover

(1) China as a potential market for U.S.  businesses, highlighting
sectors where economic expansion will require foreign expertise and
equipment;

(2) some of the challenges U.S.  businesses face in gaining market
access in China, as well as the concerns of some firms now operating
there on issues such as China's accession to the World Trade
Organization (WTO); and

(3) World Bank efforts to develop Chinese commercial standards to
meet international norms, with a special focus on the importance of
reforming China's banking and financial services sector. 


   THE EXPANDING CHINA MARKET
---------------------------------------------------------- Chapter 0:1

The size and growth rate of China's economy in recent years has made
it a large export market for the United States.  According to World
Bank figures, on a purchasing power parity basis\1 China had the
world's second largest economy in 1994, with a per capita gross
national product (GNP) of $2,510 and a population of about 1.2
billion people.  As China's economy has expanded, its demand for U.S. 
products has also grown.  U.S.  exports to China grew by 27 percent,
to $11.7 billion in 1995.  According to the Commerce Department, over
the last 5 years U.S.  exports to China have increased an average of
20 percent per year.  In 1995, U.S.  imports from China grew by 17
percent, to $45.6 billion, with a resulting trade deficit of $33.9
billion.\2

In 1995, the top five U.S.  imports from China--which accounted for
about 65 percent of total imports from China--were (1) miscellaneous
manufactured articles such as toys and games, (2) clothing and
apparel, (3) footwear, (4) telecommunications and sound recording and
reproduction equipment, and (5) electrical machinery.  According to a
senior Commerce Department official, China acts as a provider of
low-cost goods to the United States that largely compete with similar
products from India and Indonesia.  In 1995, the top five U.S. 
exports to China--which accounted for about 45 percent of total
exports to China--were (1) fertilizers, (2) transport equipment
(mainly aircraft and aircraft parts), (3) cereals and cereal
preparations, (4) textile fibers, and (5) telecommunications and
sound equipment.  According to the U.S.  Department of Agriculture,
China is an increasingly important market for U.S.  agriculture
exports.  In 1995, China purchased nearly 40 percent of all U.S. 
fertilizer exports and nearly 10 percent of all wheat and corn
exports sold by U.S.  farmers. 

Within China, U.S.  and foreign businesses continue to rapidly
increase their operations and investments.  Between 1992 and 1994,
foreign direct investment (FDI) in China increased from $11.3 billion
to $33.8 billion.  The United States is China's third largest
investor, behind Hong Kong and Macau (combined) and Taiwan, according
to Chinese statistics.  In 1995, total FDI in China was $37.5
billion, of which the U.S.  share was $3.1 billion, or 8 percent of
the total.  According to World Bank figures for 1995,\3

China was the largest developing country recipient of net FDI, with
42 percent of all FDI going to developing countries. 


--------------------
\1 The World Bank defines "purchasing power parity" as the number of
units of a country's currency that is required to buy the same
amounts of goods and services in the domestic market as one dollar
would buy in the United States. 

\2 However, as we reported in International Trade:  U.S.  Government
Policy Issues Affecting U.S.  Business Activities in China
(GAO/GGD-94-94, May 4, 1994) the U.S.  and Chinese governments
disagree over how bilateral trade statistics should be calculated. 
The Chinese government records many goods that it ships through Hong
Kong as Chinese exports to Hong Kong, while the United States records
these goods as Chinese exports to the United States. 

\3 Preliminary 1995 data from the World Bank. 


      KEY SECTORS FOR U.S. 
      EXPORTS TO CHINA
-------------------------------------------------------- Chapter 0:1.1

The World Bank estimates China's expected infrastructure development
expenditures (e.g., transportation, power generation, and
telecommunications) to be $750 billion over the next decade. 
According to the Commerce Department, between 1993 and the year 2000
China will expend $45 billion to $50 billion on transportation,
including airport construction and air traffic safety and control
capabilities.  Between 1996 and 2000, China is expected to purchase
more than 300 large passenger aircraft, with a value of $13 billion. 
Furthermore, China may spend about $65 billion to expand its energy
production.  Over the next 10 years, China's plans for economic
growth call for 168,000 megawatts of additional generating capacity
-- more than three times America's projected investment.  With regard
to telecommunications equipment and technology, the Commerce
Department expects China to spend over $10 billion between the years
1993 and 2000.  China is expected to add 100 million phone lines to
the domestic network, equal to the entire number of phone lines
already installed in the United States.  Finally, China is expected
to spend $35 billion on improving its environmental conditions. 

In sectors where U.S.  businesses hold a comparative advantage,
China's plans to develop its infrastructure continue to present
opportunities for U.S.  exports.  U.S.  entry into these sectors
remains important because initial purchases may set the standards for
technology, equipment, and services procurements which, in turn, may
encourage future exports. 


   IMPEDIMENTS TO ACCESSING THE
   CHINESE MARKET
---------------------------------------------------------- Chapter 0:2

Since China initiated its series of market-oriented reforms, it has
made progress in moving toward adopting international trading
standards, including a series of memorandums of understanding (MOU)
with the United States.  However, the transition from a nonmarket
economy to a more open, market-oriented economy has been a challenge
for both China and its trading partners.  In particular, increased
market access, enforcement of intellectual property rights (IPR)
protection, and the implementation of international trade standards
in China have been the focus of both ongoing negotiations between the
United States and China and of concern by the U.S.  business
community. 


      MARKET ACCESS
-------------------------------------------------------- Chapter 0:2.1

In October 1992, the United States and China signed a groundbreaking
MOU dealing with market access issues.  The MOU commits China, among
other things, to increase the transparency of its trade regime by
openly publishing all trade-related laws, regulations, and decrees;
removing a significant number of nontariff barriers and significantly
reducing selected tariffs; and eliminating standards and testing
requirements as barriers to trade, especially for agricultural
products. 

In January 1995, we reported on the implementation of the 1992 MOU\4

and found that while China had taken steps to comply with most of the
provisions of the agreement, U.S.  companies continued to experience
market access problems.  The most frequent concern reported by the 33
companies we interviewed was in the area of transparency, which
refers to the extent to which laws and regulations are open, clear,
measurable, and verifiable.  A majority of those who cited
transparency as a problem reported that China's trade and investment
laws are unclear, inconsistent, or administered in a seemingly
arbitrary manner.  Companies also expressed significant concern over
the high level of certain Chinese tariffs, which price U.S.  goods
out of the market.  Some U.S.  companies we interviewed also reported
problems with Chinese nontariff barriers.  The most frequently cited
were import-licensing requirements, which in some cases resulted in
increased technology transfer or increased local content and were
perceived as time-consuming and arbitrary. 

The 1996 USTR annual report on foreign trade barriers\5 shows that
these issues continue to pose problems for U.S.  businesses in China,
despite some progress.  The report indicates that the goal of
achieving transparency and uniformity of trade rules throughout China
remains elusive; that China still maintains a large number of
nontariff measures such as quotas and licensing requirements; and
that China's tariffs, in many cases, remain prohibitively high.  The
USTR report also highlights other areas of concern regarding market
access.  These include the following: 

  -- China continues to use standards and certification practices
     that the United States and other trading partners regard as
     trade barriers.  This has the effect of adding to the cost of
     manufactured goods and the outright banning of certain
     agricultural products. 

  -- Despite China's commitment to publish all laws and regulations
     affecting imports and exports, some regulations and directives
     remain unpublished.  Moreover, there is no published, publicly
     available, national procurement code in China. 

  -- China's market for services remains severely restricted.  China
     denies U.S.  and other foreign companies national treatment,\6
     and in many service sectors foreign firms are confined to
     providing services to other foreign firms or joint ventures. 


--------------------
\4 See U.S.-China Trade:  Implementation of Agreements on Market
Access and Intellectual Property (GAO/GGD-95-61, Jan.  25, 1995). 

\5 See 1996 National Trade Estimate Report on Foreign Trade Barriers,
USTR (Washington, D.C.:  1996). 

\6 National treatment is the act of treating a foreign product or
supplier no less favorably than domestic suppliers. 


      INTELLECTUAL PROPERTY
-------------------------------------------------------- Chapter 0:2.2

In recent years, the United States and China have also struggled over
an area of great importance to the United States:  intellectual
property.  In January 1992, the United States and China signed the
MOU on intellectual property, resolving USTR's Special 301
investigation\7 on China's inadequate protection of U.S.  IPR.  China
committed to revising its patent law, providing administrative
protection for certain U.S.  pharmaceutical and agricultural chemical
product inventions, enacting a law providing protection for trade
secrets, and providing effective procedures and remedies to prevent
or stop IPR infringement.  However, as we said in our January 1995
report, U.S.  companies experienced serious problems with enforcement
of China's new intellectual property regime, particularly with the
absence of a viable enforcement structure, inconsistent application
of laws and regulations, a lack of resources dedicated to IPR
enforcement, and a pervasive lack of transparency.  In 1994, USTR
again initiated a Special 301 investigation.  This led to a new MOU
on enforcement in February 1995, which was designed to address many
of the problems found in our report, particularly the protection of
copyrighted works, and trademarks, and increased market access for
products based on intellectual property. 

As with the 1992 MOU, problems occurred with the implementation of
the enforcement MOU.  The acting USTR recently testified that while
China had taken action to improve intellectual property protection,
particularly in the retail sector, it had not enforced key areas of
the 1995 agreement, including halting IPR piracy at its source.  As a
result, the United States in May 1996 announced the publication of a
retaliation list targeting Chinese exports to the United States,
which would have matched the approximate value of damage inflicted on
U.S.  industries--estimated at $2 billion.  In June 1996, China
responded and took action to close over 15 factories producing
pirated compact disks; announced a concentrated enforcement period
targeted at areas where piracy is serious, such as Guangdong; and
took steps to provide protection against the import and export of
pirated intellectual property at China's borders, among other
measures.  In addition, according to USTR, China took steps to
further open its market to U.S.  software and audiovisual companies. 
USTR plans to continue discussions with China on the need for further
progress on IPR enforcement. 


--------------------
\7 Under what has been commonly called the "Special 301" process of
the Omnibus Trade and Competitiveness Act of 1988 (P.L.  100-418, 19
U.S.C.  2242), USTR performs an annual review to identify countries
that do not provide adequate or effective protection for U.S. 
intellectual property rights.  If a country is designated a "priority
foreign country," USTR must decide within 30 days whether to initiate
an investigation into the country's IPR practices. 


      IMPLEMENTING INTERNATIONAL
      TRADE STANDARDS
-------------------------------------------------------- Chapter 0:2.3

One important goal for both China and the United States, encompassing
everything from tariffs to intellectual property rights and
agriculture, is the issue of China's entry into WTO.  The United
States has consistently held that it supports the entry of China into
WTO on the basis of a commercially viable package and on terms that
are consistent with WTO provisions.  To do so, U.S.  officials have
developed a "road map" that crystallizes the basic decisions China
must make in each substantive area covered by WTO, according to
recent USTR testimony.  The United States and China have been holding
discussions on China's WTO accession. 

Many U.S.  businesses operating in China report that, before China
enters WTO, improvements in China's market access policies are
necessary.  Based on our meeting with the American Chamber of
Commerce in Beijing and supported by a February 1996 Chamber survey
of its members, U.S.  businesses believe China's government must make
fundamental improvements, including allowing foreign companies to
engage in direct trade in China (i.e., buying and selling in their
own names), reducing import restrictions, and protecting IPR.  In
addition, in the survey almost 60 percent of the respondents said
they have not seen any significant liberalization of barriers in the
services sector, and almost 75 percent said that they have had
problems with the lack of clarity in investment regulations. 

Finally, several academic China experts we met with described the
need for improvements in the basic infrastructure of Chinese
institutions regardless of entry into WTO, such as China's legal
system and the rule of law in general; both its assemblies and its
judiciary; and the central bank and the central revenue systems. 


   WORLD BANK EFFORTS TO DEVELOP
   CHINESE COMMERCIAL STANDARDS
---------------------------------------------------------- Chapter 0:3

As China continues to reform its economy, the World Bank has provided
loans and technical assistance intended to strengthen the domestic
private sector and assist China in meeting international commercial
standards.  During the 1990s, China has been the largest recipient of
World Bank loan commitments.  Since 1981, the World Bank has
committed about $23 billion in loans and loan guarantees for over 160
projects.  According to the Chief of the World Bank's resident
mission in Beijing, Chinese leader Deng Xiaoping made China's
membership in the World Bank a priority after initiating economic
reforms in 1978.  The Chief of the mission told us that the Bank was
the first foreign financial institution China asked to help reform
its economy.  He emphasized that China has directed its own economic
reform agenda and has utilized the Bank's services as a vehicle for
developing the reform process. 


      LENDING ACTIVITIES
-------------------------------------------------------- Chapter 0:3.1

The World Bank has provided funding for various sectors, including
agriculture, transportation, energy, health, education, and the
environment.  The Bank's development efforts have included projects
related to trade, such as port facilities and railways.  Of the $23
billion in Bank funds committed for China, about $8.5 billion have
been credits from the Bank's International Development Association
(IDA).  IDA efforts in China have recently begun to focus on poverty
reduction and environmental activities.  The International Finance
Corporation, the arm of the Bank that provides loans and equity to
the private sector in developing countries, has provided about $486
million in loans and equity for 18 projects in China.  The Bank's
Multilateral Investment and Guarantee Agency has provided investment
insurance, valued at about $79 million, for about 20 projects in
China


      BANK ACTIVITIES INTENDED TO
      STRENGTHEN COMMERCIAL
      STANDARDS
-------------------------------------------------------- Chapter 0:3.2

Assisting China in implementing market-oriented reforms is a major
thrust of the Bank.  According to the Bank's resident mission Chief,
Bank operations have recently begun to focus on building institutions
necessary for private sector development.  For example, the Bank is
placing special emphasis on commercializing the operations of
state-owned enterprises and reforming the financial sector.  The
Bank's framework for helping China reform its state enterprises
involves (1) creating autonomous corporate enterprises; (2)
separating the provision of social services (e.g., housing, social
security, education, and health) from the enterprises; (3) subjecting
the enterprises to market discipline; and (4) diversifying ownership,
for example, by encouraging mergers, consolidations, sales, and
leases.  The Bank cites reforms of state-owned enterprises as key to
improving efficiency in the Chinese economy and to facilitating
reforms in the financial sector. 

To address financial sector reforms, the Bank is currently financing
a technical assistance loan to help China establish banking policies
and commercial banking practices.  Another technical assistance loan
focuses on the preparation of economic legislation, legal training,
and strengthening legal institutions responsible for legislation and
implementation of economic laws.  According to China's Ministry of
Finance officials, the Bank has promoted tariff reform, the
shareholding system, international competitive bidding, and has
helped draft 54 laws that pertain to economic development. 

As part of its efforts to promote market-oriented reforms, the Bank
is emphasizing competition in a variety of sectors, such as
transportation and energy.  In transportation, the Bank is helping
China reduce subsidies.  According to officials in Shanghai's
Municipal Finance Bureau, the transportation sector is moving from a
monopoly to an oligopoly and is reducing subsidies so that consumers
and enterprises share expenses.  The Bank is also supporting China's
efforts to ensure that enterprises in the power industry are run as
efficient businesses and are attempting to reduce barriers to entry. 
China has already introduced competition in the power sector by
holding competitive bidding for construction of most new power plants
and allowing independent power producers to compete.  Bank assistance
will continue to emphasize the transition of regional or provincial
power companies to autonomous, business-oriented entities. 

Chinese government officials told us that benefits from World Bank
financing go beyond lending and have helped improve the way
institutions operate.  For example, Chinese government officials told
us that the Bank has helped improve the managerial expertise of
government staff by introducing international competitive bidding
practices, project appraisal, and project evaluation methods. 
Officials also told us that the Bank has helped introduce financial
analysis techniques and methods for managing assets and liabilities. 
Additionally, officials from the Shanghai Municipal Electric Power
Bureau said that under World Bank loans they have sent managers
abroad to gain skills in evaluating the economic, technical, and
financial elements of projects, as well as understanding
international auditing standards and financial management. 


   REFORMING THE BANKING AND
   FINANCIAL SERVICES SECTOR
---------------------------------------------------------- Chapter 0:4

The Bank is continuing to assist China in further reforms, which
emphasize greater commercialization in banking activities.  China is
gradually opening up its financial market to foreign financial
institutions, but still limits the scope of business activities. 


      WORLD BANK ASSESSMENT OF
      CHINA'S REFORM EFFORTS
-------------------------------------------------------- Chapter 0:4.1

According to the World Bank, a primary objective of financial sector
reform in China is to phase out direct controls by the government
while relying increasingly on commercial criteria.  Although China
has implemented some reforms, the government's investment and credit
plans continue to steer most financial resources to state
enterprises, making it difficult to allocate resources efficiently
(i.e., to uses that achieve the highest return within a sound
regulatory environment).  This situation, according to the Bank, has
resulted in a large share of nonperforming loans extended by state
banks and inefficient operations. 

Based on information from the World Bank, China began changing its
banking system as early as 1978.  Since 1993, China has made the
People's Bank of China responsible for monetary policy and
supervision of the financial system, has created three policy banks
to separate "policy" lending from commercial lending, and has granted
increased autonomy in investment lending decisions to state
commercial banks.  To continue reforming the financial sector, the
World Bank has recommended, among other things, that China (1) give
further autonomy to state commercial banks by allowing them to design
their entire lending program on their own, (2) facilitate the
transformation of state commercial banks into genuine commercial
banks, (3) reform interest rates to reduce the large number of
officially-determined interest rates, and (4) strengthen regulatory
oversight of nonbank financial institutions.  Although legislation
authorizes the People's Bank of China to set monetary policy, China's
State Council must still approve its decisions, according to the U.S. 
Treasury Department. 


      OTHER REFORMS
-------------------------------------------------------- Chapter 0:4.2

According to the U.S.  Treasury Department, China has taken actions
to increase the participation of foreign financial institutions.  For
example, China has gradually expanded the number of cities and
special economic zones in which foreign financial institutions may
apply for licenses.  After consultations with the U.S.  Treasury
Department, China agreed in 1994 to accept applications for licenses
in 12 additional cities, including Beijing.  China has been slow to
actually grant the licenses, however.  Before 1996, foreign-invested
firms doing business in China used "swap centers" to get foreign
exchange for approved current account transactions.  Effective
February 1996, foreign-invested and domestic firms have the option of
using swap centers or purchasing foreign exchange from designated
Chinese banks, currently located in Shanghai, Shenzhen, Dalian, and
Jiangsu.  These locations account for about 70 percent of China's
foreign exchange transactions, according to the U.S.  Treasury
Department. 


      LIMITATIONS IN THE SCOPE OF
      BUSINESS FOR FOREIGN
      FINANCIAL INSTITUTIONS
-------------------------------------------------------- Chapter 0:4.3

Although China has made some progress in reforming its banking and
financial sectors, it continues to limit the scope of business for
foreign financial institutions.  Currently, foreign financial
institutions may only conduct transactions in foreign currency and
are not allowed to do business in local currency (or "renminbi"). 
This year, articles in the Chinese press have said that the State
Council has decided to allow some foreign banks to engage in renminbi
business in selected districts, such as the Shanghai-Pudong district. 
According to these articles, foreign banks would be limited to taking
deposits and lending in local currency only to foreign-funded
companies or foreign-related firms.  However, no action has been
taken on this announcement, according to the U.S.  Treasury
Department. 

Further limitations in foreign participation in the financial sector
extend to the stock market.  China's two stock exchanges are located
in Shanghai and Shenzhen.  Both exchanges have introduced a variety
of shares, but foreign investors are prohibited from investing in
most shares, thus limiting the opportunity for foreigners' portfolio
equity investment.  The U.S.  Treasury Department noted that at the
end of 1994, shares available to foreign investors accounted for less
than 3 percent of total market capitalization in the two stock
exchanges.  Additionally, foreign firms may only establish
representative offices and may only broker shares purchased
exclusively by foreign-invested companies or foreign residents. 
Foreign firms must also work with a domestic broker on the basis of a
shared commission and may not underwrite local securities issues or
act as dealers or brokers in renminbi-denominated securities in the
primary or secondary market. 


   THE NEED FOR FURTHER REFORM
---------------------------------------------------------- Chapter 0:5

There is widespread agreement that further liberalization of the
Chinese market is in the interest of U.S.  businesses and will be
necessary for China to maintain its high growth rates.  U.S. 
businesses and USTR have argued that the United States should have
access in China's markets equivalent to that which China receives in
the United States.  Currently, however, market access for U.S.  and
foreign businesses in China is inhibited by Chinese government
measures to protect its state-run economy.  According to a May 1996
World Bank country study on China, sustaining growth and maintaining
economic stability will require further progress in the government's
reliance upon market forces.  While China has agreed to remove
certain barriers to trade in response to ongoing negotiations with
USTR, other trade barriers remain that limit exports and require
continuous monitoring to protect and further U.S.  interests. 


-------------------------------------------------------- Chapter 0:5.1

Mr.  Chairman and Members of the Committee, this concludes my
prepared statement, which incorporates comments obtained from the
U.S.  Trade Representative, the Department of the Treasury and the
Department of Commerce.  I will be happy to answer any questions you
or other Members of the Committee may have. 


*** End of document. ***