[2013 Report to Congress of the U.S.-China Economic and Security Review Commission]
[2013 Report to Congress of the U.S. China Economic and Security Review Commission]
[From the U.S. Government Printing Office, www.gpo.gov]
2013
REPORT TO CONGRESS
of the
U.S.-CHINA ECONOMIC AND
SECURITY REVIEW COMMISSION
ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION
__________
NOVEMBER 2013
__________
Printed for the use of the
U.S.-China Economic and Security Review Commission
Available via the World Wide Web: http://www.uscc.gov
____________
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U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION
Hon. WILLIAM A. REINSCH, Chairman
Hon. DENNIS C. SHEA, Vice Chairman
COMMISSIONERS
CAROLYN BARTHOLOMEW DANIEL M. SLANE
PETER T.R. BROOKES Hon. JAMES M. TALENT
ROBIN CLEVELAND Hon. KATHERINE C. TOBIN
JEFFREY L. FIEDLER MICHAEL R. WESSEL
Hon. CARTE P. GOODWIN LARRY M. WORTZEL
Michael R. Danis, Executive Director
The Commission was created on October 30, 2000, by the Floyd D.
Spence National Defense Authorization Act for 2001 Sec. 1238,
Pub. L. No. 106-398, 114 STAT. 1654A-334 (2000) (codified at 22
U.S.C. Sec. 7002 (2001), as amended by the Treasury and General
Government Appropriations Act for 2002 Sec. 645 (regarding
employment status of staff) & Sec. 648 (regarding
changing annual report due date from March to June),
Pub. L. No. 107-67, 115 STAT. 514 (Nov. 12, 2001); as amended
by Division P of the ``Consolidated Appropriations Resolution,
2003,'' Pub. L. No. 108-7 (Feb. 20, 2003) (regarding Commission
name change, terms of Commissioners, and responsibilities of
Commission); as amended by Pub. L. No. 109-108 (H.R. 2862)
(Nov. 22, 2005) (regarding responsibilities of Commission and
applicability of FACA); as amended by Pub. L. No. 110-161 (Dec.
26, 2007) (regarding changes in annual report due date;
submission of financial reports; printing and binding of
Congressional reports; employee compensation and performance
reviews; and applicability of House rules for travel by members
and staff).
The Commission's full charter http://www.uscc.gov/about/uscc-
charter and Statutory Mandate http://www.uscc.gov/about/
fact--sheet are available via the World Wide Web.
(ii)
U.S.-China Economic and Security Review Commission
November 13, 2013
The Honorable Patrick Leahy,
President Pro Tempore of the U.S. Senate, Washington, DC 20510
The Honorable John Boehner,
Speaker of the U.S. House of Representatives, Washington, DC 20510
Dear Senator Leahy and Speaker Boehner:
On behalf of the U.S.-China Economic and Security Review
Commission, we are pleased to transmit the Commission's 2013
Annual Report to the Congress--the eleventh major Report
presented to Congress by the Commission--pursuant to Public Law
106-398 (October 30, 2000), as amended by Public Law No. 109-
108 (November 22, 2005). This report responds to the mandate
for the Commission ``to monitor, investigate, and report to
Congress on the national security implications of the bilateral
trade and economic relationship between the United States and
the People's Republic of China.'' In this Report, the
Commission reached a broad and bipartisan consensus, approving
the Report by a vote of 11 ayes to 1 nay.
In accordance with our mandate, this Report, which is
current as of November 13, includes detailed treatment of our
investigations of the areas identified by Congress for our
examination and recommendation. These areas are:
PROLIFERATION PRACTICES--The role of the People's
Republic of China in the proliferation of weapons of mass
destruction and other weapons (including dual-use
technologies), including actions the United States might take
to encourage the People's Republic of China to cease such
practices;
ECONOMIC TRANSFERS--The qualitative and quantitative
nature of the transfer of United States production activities
to the People's Republic of China, including the relocation of
high technology, manufacturing, and research and development
facilities, the impact of such transfers on United States
national security, the adequacy of United States export control
laws, and the effect of such transfers on United States
economic security and employment;
ENERGY--The effect of the large and growing economy
of the People's Republic of China on world energy supplies and
the role the United States can play (including joint research
and development efforts and technological assistance), in
influencing the energy policy of the People's Republic of
China;
UNITED STATES CAPITAL MARKETS--The extent of access
to and use of United States capital markets by the People's
Republic of China, including whether or not existing disclosure
and transparency rules are adequate to identify People's
Republic of China companies engaged in harmful activities;
REGIONAL ECONOMIC AND SECURITY IMPACTS--The
triangular economic and security relationship among the United
States, [Taiwan] and the People's Republic of China (including
the military modernization and force deployments of the
People's Republic of China aimed at [Taiwan]), the national
budget of the People's Republic of China, and the fiscal
strength of the People's Republic of China in relation to
internal instability in the People's Republic of China and the
likelihood of the externalization of problems arising from such
internal instability;
UNITED STATES-CHINA BILATERAL PROGRAMS--Science and
technology programs, the degree of noncompliance by the
People's Republic of China with agreements between the United
States and the People's Republic of China on prison labor
imports and intellectual property rights, and United States
enforcement policies with respect to such agreements;
WORLD TRADE ORGANIZATION COMPLIANCE--The compliance
of the People's Republic of China with its accession agreement
to the World Trade Organization (WTO); and
FREEDOM OF EXPRESSION--The implications of
restrictions on speech and access to information in the
People's Republic of China for its relations with the United
States in the areas of economic and security policy.
The Commission conducted its work through a comprehensive
set of seven public hearings and one public roundtable, taking
testimony from 57 witnesses from the executive branch,
industry, academia, policy groups, and other experts. For each
of its hearings, the Commission produced a transcript (posted
on its Web site--www.uscc.gov). The Commission also received a
number of briefings by officials of executive branch agencies,
intelligence community agencies, and the armed services,
including classified briefings on Chinese investment, China's
cyber operations, China's foreign policy, and China's navy. The
Commission is preparing a classified report to Congress on
these and other topics.
Commissioners also made an official delegation visit to
Taiwan, Japan, China, and Hong Kong to hear and discuss
perspectives on China and its global and regional activities.
In these visits, the Commission delegations met with U.S.
diplomats, host government officials, representatives of the
U.S. and foreign business communities, and local experts.
The Commission also relied substantially on the work of its
excellent professional staff, and supported outside research in
accordance with our mandate.
The Report includes 41 recommendations for Congressional
action. Our 10 most important recommendations appear on page 27
at the conclusion of the Executive Summary.
We offer this Report to the Congress in the hope that it
will be useful as an updated baseline for assessing progress
and challenges in U.S.-China relations.
Thank you for the opportunity to serve. We look forward to
continuing to work with you in the upcoming year to address
issues of concern in the U.S.-China relationship.
Yours truly,
William A. Reinsch Dennis C. Shea
Chairman Vice Chairman
CONTENTS
----------
Page
Transmittal Letter to the Congress............................... iii
Commissioners Approving the Report............................... v
Executive Summary................................................ 1
Key Recommendations.......................................... 27
Introduction..................................................... 31
2013 Report To Congress of the
U.S.-China Economic and Security Review Commission
Chapter 1: The U.S.-China Trade and Economic Relationship........ 35
Section 1: Trade and Economics Year in Review................... 35
Section 2: Trends in Chinese Investment in the United States.... 91
Section 3: Governance and Accountability in China's Financial
System....................................................... 113
Section 4: China's Agriculture Policy, Food Regulation, and the
U.S.-China Agriculture Trade................................. 153
Recommendations................................................. 203
Chapter 2: China's Impact on U.S. Security Interests............. 207
Section 1: Military and Security Year in Review................. 207
Section 2: China's Cyber Activities............................. 243
Section 3: China's Maritime Disputes............................ 266
Recommendations................................................. 293
Chapter 3: China and the World................................... 295
Section 1: China and the Middle East and North Africa........... 295
Section 2: Taiwan............................................... 325
Section 3: Macau and Hong Kong.................................. 354
Recommendations................................................. 395
Comprehensive List of the Commission's Recommendations........... 397
Additional Views of Commissioners................................ 403
Appendices:
Appendix I: U.S.-China Economic and Security Review Commission
Charter........................................................ 415
Appendix II: Background of Commissioners....................... 425
Appendix III: Public Hearings of the Commission During 2013..... 435
Appendix IIIA: List of Witnesses Testifying Before the Commission
During 2013.................................................... 439
Appendix IV: List of Interlocutors During Commission Fact-
Finding Trips
to Asia During 2013............................................ 443
Appendix V: List of Research Material.......................... 445
Appendix VI: Acronyms and Abbreviations......................... 449
2013 Commission Staff and Acknowledgements....................... 453
EXECUTIVE SUMMARY
Chapter 1: The U.S.-China Trade and Economic Relationship
Trade and Economics Year in Review
China's economy grew at a 7.66 percent annualized rate in
the first three quarters of 2013, continuing a three-year trend
of decelerating output. This marked a significant decline from
the three decades of growth in the 1980s, 1990s, and 2000s
averaging 10 percent annually. Demand for China's exports
stalled, and the domestic economy adjusted to a drop in
government spending on massive infrastructure projects--
undermining the two main pillars of China's economic surge over
the previous decade.
China underwent a leadership change with a new president
and premier and several new members of the Politburo and
Standing Committee. No prominent political or economic
reformers were elevated to the Politburo Standing Committee,
China's highest decision-making body, though the backgrounds of
Wang Qishan and Zhang Gaoli suggest that they might be open to
further economic reform. There is uncertainty over the
prospects for economic reform as a result of contradictory
statements and actions by the new leadership. While there are
signs that President Xi Jinping and Premier Li Keqiang are
preparing a package of reforms to be unveiled at the Third
Plenary Session of the 18th Central Committee, expected to take
place in November 2013, President Xi has also been reaffirming
the role of the state in the economy and introducing Maoist-
style ideological campaigns aimed at stamping out political
liberalization. In recent months, the government has introduced
some important initiatives aimed at addressing some of the
country's growing inequalities of wealth and opportunity. One
initiative has been a focus on urbanization. The hope is that
urbanization will become the next growth engine, initiating a
new wave of investment, adding to the consumer class, and
creating a surge in demand for housing and infrastructure. The
urbanization drive may also boost Chinese efforts to make more
land available for agriculture and improve farming efficiency.
Growing demand from China has supported exporters in
certain sectors of the U.S. economy, such as aerospace, the
auto industry, and agricultural products. However, the U.S.
trade deficit with China continues to widen. In July 2013, the
monthly deficit exceeded $30 billion for the first time.
Moreover, the Chinese government policies driving economic
growth have resulted in what the International Monetary Fund
(IMF) calls a ``pattern of growth [that] has become too reliant
on investment and an unsustainable surge in credit, resulting
in rising domestic vulnerabilities.'' The most important--and
most challenging--element of domestic rebalancing is increasing
household consumption as a share of gross domestic product
(GDP), which has declined as a share of China's GDP for decades
while the share of fixed-asset investment has grown.
China continues to intervene in foreign exchange markets to
keep its currency undervalued. Such interventions, combined
with China's subsidies to exporting industries, have helped
China accumulate the world's largest foreign currency
reserves--$3.66 trillion by the end of September 2013. While
maintaining a preference for government securities, China
continues to diversify its foreign exchange assets. China's
nonfinancial outbound foreign direct investment (FDI) for the
first half of 2013 totaled $45.6 billion, up 29 percent from
the prior year. China rapidly accumulated foreign currency in
2013, but the pace of currency inflows varied during the course
of the year. In the first quarter, currency inflows surged,
followed by outflows in the second quarter as the country's
banks encountered a liquidity crisis. These movements caused
volatility in China's external accounts that carried over into
the domestic financial sector.
Trends in Chinese Investment in the United States
China has amassed the world's largest trove of dollar-
denominated assets. Although the true composition of China's
foreign exchange reserves, valued at $3.66 trillion, is a state
secret, outside observers estimate that about 70 percent is in
dollars. In recent years, China has become less risk averse and
more willing to invest directly in U.S. land, factories, and
businesses. This trend appears to be accelerating. In June
2013, China announced its largest purchase of a U.S. asset to
date: a $7.1 billion acquisition of Virginia-based Smithfield
Foods, Inc. Given China's large holdings of U.S. dollars, China
has a huge potential for FDI, particularly if China should
substitute or abandon portfolio investment for direct
investment.
The 12th Five-Year Plan (2011-2016) called for a three-
pronged approach for increasing China's investment abroad.
First, Chinese manufacturing companies should invest overseas
in order to establish international networks and globally
recognized brands. Second, Chinese companies should invest in
research and development outside of China. Lastly, the plan set
goals for shifting acquisitions toward sectors that promote a
high-tech economy. This policy focused on investment goals in
which domestic state-owned or state-controlled firms were
already intended to be dominant by policy. These sectors
included energy, machinery, construction, and information
technology. The Chinese government wields many tools to drive
these goals, including requiring permission for overseas
investments by Chinese firms.
Despite China's large holdings of portfolio investment,
China's FDI is still relatively modest. According to the U.S.
Bureau of Economic Analysis, in 2012, the United States
attracted $174.7 billion of global FDI, of which only $219
million came from China. Official estimates of Chinese FDI in
the United States are too low, because they do not account for
flows of FDI though Hong Kong and other offshore financial
centers, among other things. Chinese FDI in the United States
has emphasized services, energy, and technology and is notable
for its focus on brand acquisition.
State-owned enterprises (SOEs) have dominated Chinese FDI
in the United States, making investments that follow the
industrial policies of the Chinese government. Chinese SOEs
receive substantial benefits from the central and provincial
governments that are not available to their foreign
competitors, including preferential policies and low cost of
capital. Furthermore, SOEs investing in the United States may
engage in particular predatory or anticompetitive behavior that
U.S. trade remedies cannot address.
Trade-related aspects of foreign investments often
intersect with national security concerns. For example, foreign
intelligence collection efforts and espionage that target U.S.
technology, intellectual property, trade secrets, and other
proprietary information can be concealed under the pretext of
foreign investment in cleared government contractors. The
United States has a limited screening process for determining
the potential national security threat from a specific foreign
investment. The Committee on Foreign Investment in the United
States (CFIUS) is an interagency committee that reviews certain
mergers, acquisitions, and takeovers of U.S. businesses by
foreign persons, corporations, or governments for national
security risks. China presents new challenges for CFIUS,
because investment by SOEs can blur the line between national
security and economic security. The possibility of government
intent or coordinated strategy behind Chinese investments
raises national security concerns. For example, Chinese
companies' attempts to acquire technology track closely the
government's plan to move up the value-added chain. There is
also an inherent tension among state and federal agencies in
the United States regarding FDI from China. The federal
government tends to be concerned with maintaining national
security and protecting a rules-based, nondiscriminatory
investment regime. The state governments are more concerned
with local economic benefits, such as an expanded tax base and
increased local employment, rather than national strategic
issues, especially as job growth has stagnated.
Governance and Accountability in China's Financial System
China's 12th Five-Year Plan calls for less dependence on
exports and state-funded infrastructure projects and more
domestic consumption to support China's economy. A shift from
government-led to private-led growth requires that Chinese
families and private sector businesses have sufficient access
to credit and capital. Bank lending, the traditional source of
credit for entrepreneurs and startups in most countries, is
largely inaccessible to Chinese individuals and small- to
medium-sized enterprises (SMEs), because China's financial
system is dominated by large, state-owned banks that mainly
service government-directed projects.
Banks hold a unique position in China and are even more
important to the national economy than banks in Europe or North
America, where alternate sources of financing are available.
China's financial sector is dominated by five massive, state-
owned commercial banks that account collectively for about 50
percent of all deposits and loans. Additionally, three policy
banks were established in 1994 to take over government-directed
spending functions like financing of major development
projects. China's policy banks are funded primarily by selling
bonds to the big commercial banks, and all are ultimately back-
stopped by the Chinese government. The incestuous relationship
between the government; the large, state-owned policy banks;
and their state-owned commercial cousins provides borrowers a
considerable benefit: artificially low interest rates. The
banks' depositors, meanwhile, are paid very low rates,
sometimes below the rate of inflation, to help hold down the
rates charged to borrowers. Thus, the state-owned corporate
sector receives a subsidy from the bank's depositors (Chinese
households) in the form of low interest rates.
A ``shadow banking system'' of unofficial credit has sprung
up to fill the gaps left by the big banks' lending practices.
China's shadow banking system can broadly be defined as lending
that falls outside of the official banking system. It can
involve both traditional and nontraditional institutions and is
best understood not in terms of the institutions engaged in the
system but in terms of the activities that they undertake.
Because shadow banking activity occurs outside of formal
banking channels, it does not appear on bank balance sheets and
is far less transparent than official lending activity. Chinese
demand for shadow banking is largely driven by the growth of
China's private sector, a sector with limited access to
official bank credit; and the Chinese government's tolerance of
shadow banking in recent years has been tied to the reality
that the private sector is the increasingly dominant source of
the nation's employment.
Demand for credit has led Chinese companies to seek capital
overseas even as its shadow banking system has expanded. In the
late 1990s, Chinese companies began raising capital on major
international stock exchanges. This trend has been driven by
large Chinese companies, many state owned, that have sought to
broaden their shareholder base, increase the liquidity of their
shares, and enhance the visibility of their brand names. U.S.
stock markets are among the most popular global exchange
destinations for Chinese firms.
Initially, U.S. investors purchased stock in U.S.-listed
Chinese companies in hopes of profiting from China's rapid
growth rate. However, investors in U.S.-listed Chinese
companies have increasingly found that insufficient corporate
governance standards make these companies high-risk
investments. Many have been implicated in frauds and accounting
scandals, and U.S. regulators have deregistered about 50
Chinese companies in the past two years following fraud probes.
During recent probes, the Securities and Exchange Commission
(SEC) has sought audit work papers from Chinese branches of
multinational accounting firms that service U.S.-listed Chinese
companies, a common request during fraud investigations. To
date, the firms have refused to produce these documents,
arguing that doing so would put them in violation of Chinese
state secrets laws and subject them to criminal liability in
China. In December 2012, the SEC charged five firms with
breaking U.S. securities laws by refusing to turn over the
requested audit work papers.
In May 2013, the United States and China announced a deal
for limited information-sharing between their regulatory
agencies when there are questions regarding audits of U.S.-
listed Chinese companies. In July, Chinese regulators agreed to
turn over certain requested documents of some listed Chinese
companies to assist the SEC in ongoing investigations. No
agreement has yet been reached that would grant more general
direct access to documents for U.S. regulators conducting
investigations or inspections. Although it is considered a last
resort option, if an agreement is not reached, the SEC and the
Public Company Accounting Oversight Board could choose to ban
Chinese accounting firms and Chinese branches of multinational
accounting firms from auditing U.S.-listed Chinese companies,
which could in turn lead to these companies being delisted from
U.S. exchanges.
China's Agriculture Policy, Food Regulation, and the U.S.-China
Agriculture Trade
China's World Trade Organization (WTO) accession in 2001
was a watershed event for U.S. agriculture. China is now the
primary export market for U.S. agriculture products. While the
United States ran a $315 billion trade deficit in goods with
China in 2012, it achieved a $21 billion surplus in
agriculture. Since full implementation of the WTO accession in
2005, China's agriculture imports from the United States have
risen by an average of $2.5 billion each year, exceeding the
U.S. Department of Agriculture's (USDA) initial estimate of $2
billion. China must feed a fifth of the world's population with
less than a tenth of its arable land and potable water. As
China transforms into an urban society with a growing middle
class, per capita food consumption is rising and, with it, the
demand for higher-protein diets--a demand that U.S. farmers are
well positioned to fill.
There remain serious problems within the U.S.-China
bilateral agriculture trade relationship, however. Many in the
U.S. agriculture industry lobbied Congress in 2000 to grant
China permanent normal trade relations, because they expected
China to become a major purchaser of U.S. food products once it
joined the WTO. But farm belt advocates have been disappointed
that China has concentrated its purchases on bulk commodities,
such as soybeans used as animal feed for China's outsized
livestock industry. China's agriculture policy favors domestic
production, even when it is unsustainable and nonessential to
food security. In trade, China has used nontariff barriers to
restrict imports of higher value-added products from the United
States, including excessive subsidies; government control over
import quotas; discriminatory taxes; and sanitary and
phytosanitary restrictions that are not based on proper
scientific analysis. These measures have contributed to an
imbalanced food trade that has been particularly damaging to
U.S. meat producers, who enjoy a comparative advantage over
China in terms of resources, quality, and efficiency.
China's agribusinesses have pursued outbound investment in
several countries and sectors in recent years. In the United
States, this trend came into focus in June 2013, when Shuanghui
International Holdings Limited, a subsidiary of Shuanghui
Group, proposed to acquire the U.S. pork producer Smithfield
Foods, Inc. As the largest U.S. pork producer, Smithfield is a
strategic node in the U.S. food industry.
China's WTO accession was primarily envisaged as an
opportunity for U.S. exporters. But U.S. consumer food imports
from China have surged as well, part of a greater reliance on
imported food by U.S. consumers. The bulk of U.S. food imports
from China consists of farm-raised fish and fruits and
vegetables. China also supplies ingredients for U.S.-processed
foods, as well as organic foods that are USDA-approved through
third-party certifiers. For the United States, these imports
from China present significant food safety risks. Over the past
decade, China's major trade partners have repeatedly banned its
food shipments on the basis of food safety. Current regulation
of food entering the United States from China is insufficient.
For one, the Chinese government's own food safety regulation is
inadequate. The Chinese government in 2009 introduced a
comprehensive Food Safety Law to establish a modern framework
for food safety regulation and in 2013 created a China Food and
Drug Administration to consolidate regulatory authority.
However, it is uncertain whether these and other reforms will
improve oversight of China's large and fragmented food
industry.
In the absence of effective regulation by the Chinese
government, U.S. consumers depend on U.S. food safety
inspectors to provide protection against the importation of
unsafe food products. The Food and Drug Administration (FDA),
which is in charge of inspecting all nonmeat imports, is making
substantial efforts to dedicate more staff and funding to
China, to modernize its regulatory system, and to propose
useful policies, such as foreign supplier verification. And
yet, there are numerous problems with U.S. food regulation. The
FDA still inspects only a fraction of the food that enters
through U.S. borders. The agency has also found it difficult to
increase on-the-ground inspections on the Mainland, in part
because Chinese authorities have delayed visas for FDA
inspectors and restricted access to food production sites.
Conclusions
Trade and Economics Year in Review
LChina underwent a once-a-decade leadership change
with a new president and premier and several new members of the
Politburo and Standing Committee. The leadership indicated that
China's overall economic policy goal--to transition from an
export and investment-led growth model to a greater reliance on
domestic consumption, remained the same. In reality, this
change proved difficult to implement by a new government
concerned about a slowing economy, real estate speculation,
stagnating wages, and unemployment. The incoming government
issued statements supporting a large and powerful state-owned
sector in the economy, disappointing advocates of a larger
private sector.
LThe new Chinese leadership introduced initiatives
aimed at reducing inequality, cracking down on corruption, and
promoting urbanization. There are significant impediments to
the government's ability to implement these reforms. For
example, corruption is endemic at all levels of government,
while local governments oppose urbanization due to fear that
they will be overwhelmed by a flood of new migrants.
LChina's progress in external rebalancing
following the financial crisis was only temporary and largely
driven by a weak global demand that reduced the relative size
of China's export sector. Trade data for 2012-13 show that
Chinese exports are again growing at a higher rate than
imports, signaling a continued reliance on exports to fuel
economic growth and a reversal in reducing China's massive
trade surplus. As a result of failed measures to rebalance its
economy, China has continued to expand its already record
foreign currency reserves, reaching $3.66 trillion by the end
of September 2013.
LChina's trade surplus with the United States in
goods in 2012 was $315 billion, a record. For the first seven
months of 2013, China's trade surplus with the United States
was $178 billion, also a record. China continues to manipulate
the value of its currency, the RMB, to achieve a competitive
advantage with the United States. China also continues to
follow mercantilist policies to foster a trade surplus with the
United States.
LChina has had little success transitioning toward
a consumption-led growth model and reducing its reliance on
massive infrastructure projects to boost economic growth.
Consequently, China's high investment levels have led to
overcapacity in multiple industries, including steelmaking,
shipbuilding, and solar panel manufacturing. A slowdown in
urban household disposable income growth and an increase in the
household savings rate have cut into consumer purchasing power
and contributed to a decline in total retail sales growth.
LChinese officials have played down the
significance of lower growth, saying the slowdown is partly due
to economic rebalancing. However, the government continues to
stimulate the economy through a variety of small steps. For
example, the State Council, China's cabinet, instituted a
temporary tax cut (scraping all value-added and operating
taxes) for more than 6 million small- and medium-sized
enterprises; reduced approval procedures and administrative
costs for exporting companies; and provided more investment in
railway construction in China's central and western regions. In
a similar vein, securities regulators and the central bank
issued record amounts of investment approvals to the Qualified
Foreign Institutional Investors program.
LDue to its restrictive monetary policy, China's
central bank has accumulated the world's largest foreign
exchange reserves. The bulk of these reserves are invested in
U.S. Treasury securities, so that Chinese ownership accounts
for nearly one-quarter of foreign-owned U.S Treasuries. In
addition, China's two largest sovereign wealth funds, China
Investment Corporation and SAFE Investment Company, have
expanded their equity and real estate investments in the United
States.
LThe People's Republic of China (PRC) has
concluded 13 trade agreements, the latest with Iceland and
Switzerland this year--the first signed with European
governments. China is in the process of negotiating six
additional trade agreements, which include the ASEAN-led
Regional Comprehensive Economic Partnership, an initiative to
link ASEAN member states and preferential trade agreement
partners to form the world's largest trading bloc. The Regional
Comprehensive Economic Partnership, which excludes the United
States, is competing with the U.S.-led Trans-Pacific
Partnership, which excludes China. Formal negotiations of the
Regional Comprehensive Economic Partnership began in May 2013
and are scheduled to conclude by the end of 2015.
LChina's attempts to keep the value of the RMB
artificially low while strictly limiting the flow of RMB from
the country, coupled with its efforts to control a large state
banking sector, led to a banking crisis. The collapse in
liquidity threatened economic growth in China and demonstrated
the difficulty of conducting a monetary policy so at odds with
its trading partners and international norms.
LThe fifth round of the U.S.-China Strategic and
Economic dialogue was held on July 10-11, 2013, in Washington,
DC. There were no significant achievements in the strategic
track. On the economic front, the most relevant announcements
were (1) resumption of bilateral investment treaty talks; (2)
the launch of the Shanghai Free Trade Zone; and (3) new
measures to liberalize China's financial sector. In the
multilateral arena, the United States successfully challenged
China's improper imposition of antidumping and countervailing
duties at the WTO.
LChina continues to take incremental steps toward
RMB internationalization, but the goal of making the RMB a
major international currency remains out of reach as the
government continues to maintain strict controls on cross-
border capital flows.
LBeijing's efforts to reform the financial system
continue to be hampered by risky off-balance-sheet lending by
banks and nonbank financial institutions. Beijing has
undertaken efforts to curb these risky lending practices,
removing the floor on lending rates and imposing a short-term
credit crunch in a clumsy effort to send a strong signal to the
financial sector. However, there is little evidence so far that
these efforts have succeeded. The ceiling on rates paid to
depositors remains low, and some risky lending actually
increased during the credit crunch.
Trends in Chinese Investment in the United States
LChinese foreign direct investment (FDI) in the
United States continues to grow, though from a very low base.
According to official U.S. statistics, in 2012 the United
States attracted $174.7 billion of global FDI, of which $219
million came from China. An estimate by country of ultimate
beneficiary owner, which better tracks actual investors, put
stock of Chinese FDI in the United States at $9.5 billion at
the end of 2011. For the same year, China's Ministry of
Commerce put the flows of Chinese FDI to the United States at
$1.8 billion, with stock of FDI estimated at around $9 billion.
LOfficial statistics underestimate the true volume
of Chinese investment, because they do not account for flows of
FDI through Hong Kong and other offshore financial centers,
which are likely transit points for Chinese money on the way to
the real investment destination. Official data are also
provided after a significant delay, which hinders analysis.
LTo date, state-owned enterprises (SOEs) have
dominated Chinese FDI in the United States measured by the
value of deals, though private companies lead by the number of
deals. One reason is that the biggest investments so far have
been made in the oil and energy fields, which are dominated by
Chinese state-owned giants.
LChinese investors have primarily targeted those
sectors where China lacks know-how and technology, particularly
in the Strategic and Emerging Industries identified in the 12th
Five-Year Plan. Energy and services (in particular real estate
and financial services) have received the most investment.
High-end manufacturing is another important destination for
China's investments, particularly when measured in terms of the
number rather than the value of deals.
LDue to the considerable government ownership of
the Chinese economy, provision by Chinese companies of critical
infrastructure to U.S. government or acquisition by Chinese
companies of U.S. firms with sensitive technology or
intellectual property could be harmful to U.S. national
interests. The Committee on Foreign Investment in the United
States (CFIUS) investigates the national security implications
of mergers and acquisitions by foreign investors of U.S.
assets.
LInvestigations by CFIUS and other national
security review and mitigation mechanisms may be hampered by
limited resources or limited statutory authority.
LInvestments made by Chinese state-owned or -
controlled companies can also pose economic security threats.
The Chinese government provides significant financial and
logistical support. This puts U.S. firms, which receive no such
support, at a competitive disadvantage. When Chinese SOEs
invest abroad, they do not necessarily seek profit and may
instead pursue government goals such as resource acquisition or
technology transfer.
LChinese investments in the United States are
subject to the same set of rules and regulations as investment
from other foreign countries in the areas of foreign corrupt
practices, export administration, sanctions, and antitrust. If
Chinese firms run afoul of these rules, they will be subject to
legal sanction. But gaps exist in the U.S. government's ability
to address the competitive challenges posed by SOEs.
LIn areas where there are no national security
considerations, and when the investment is driven by economic
rather than strategic rationale, Chinese FDI can benefit the
U.S. economy through creation of jobs and other positive
spillovers.
Governance and Accountability in China's Financial System
LThe Chinese economy weathered the first few years
of the global economic downturn by doubling down on its time-
tested strategy of funneling capital into domestic development
projects. But five years on, global demand for Chinese exports
remains too weak to sustain the country's factories, much less
new ones, and the merits of massive infrastructure projects
have more than run their course. The policy decisions that kept
the Chinese economy chugging over the last few years have also
sped it closer to a reckoning that economists have long
forecast would eventually be necessary. If a rebalancing of the
U.S.-China economic relationship is to be achieved, China must
reform its financial system to support newer, nonstate sources
of economic growth, which will require that China's banks
better service its private sector.
LAs long as China's official, regulated channels
of credit do not possess the flexibility to meet the needs of
the Chinese economy's main job creators, China will be at risk
of depressed economic growth, which in turn may limit the
growth of U.S. exports to China and the prosperity of U.S.
investments in China, slowing economic recovery here at home.
The shadow banking system that Beijing has allowed to step into
this credit gap is insufficiently regulated and, if left
unchecked, will pose an increasingly serious threat to Chinese
and global economic stability.
LThe opacity of Chinese corporate governance and
accountability policies, as well as conflicts with U.S.
securities laws and regulations, hurts investor confidence in
Chinese companies trading on U.S. exchanges. The current
situation threatens U.S. investors with unforeseeable and
unmanageable losses and may lead to a broad delisting of
Chinese companies. China's lack of sophisticated banking,
corporate governance, and auditing policies and practices also
hinders much-needed growth and opportunity for the very U.S.
financial services firms that could help China to restructure
its system if they were allowed greater access to the Chinese
market.
LInsufficient transparency and accountability in
China's financial sector put U.S. firms at risk of violating
laws in both China and the United States; pose unreasonable
hazards for U.S. investors with shares in Chinese companies;
and render some U.S. laws and regulations unenforceable.
Without greater regulatory transparency and assurance of
China's regulatory, oversight and enforcement capabilities,
Chinese firms also risk curtailment or even revocation of
access to the U.S. market.
China's Agriculture Policy, Food Regulation, and the U.S.-China
Agriculture Trade
LFor the past three years, China has been the
largest export market for U.S. agricultural goods. However,
trade is far from free, and enormous opportunities are being
withheld. China's WTO accession has not been as productive to
the United States as initially expected. In contrast to U.S.
agricultural exports to the rest of the world, most U.S.
exports to China are bulk commodities, particularly raw
soybeans that supply China's outsized livestock sector.
Conversely, processed commodities, meat products, consumer
foods, and other higher value-added products have not kept pace
with the overall growth in bilateral trade.
LSince the 1980s, China has developed into the
world's largest agricultural economy, producing a fifth of the
world's grains, a quarter of its meat, and half of its
vegetables. But demand in China is beginning to outstrip
supply. As more people move to cities and earn higher incomes,
China's population is demanding safer food and a more diverse,
protein-rich diet at an affordable cost. The United States is
well-positioned to meet that demand. U.S. farmers enjoy a
comparative advantage in resources, productivity, and quality,
particularly in meat production.
LChina's agriculture policy favors domestic
production over imports. China maintains ambitious self-
sufficiency targets that are unsustainable and unjustifiable in
terms of food security. This policy is now being challenged by
the decline in China's farm labor surplus, deteriorating land
and resource endowments, and fragmented producer and land use
systems. A related problem is that efforts to modernize
agriculture conflict with rural welfare aims. Millions of rural
migrants continue to rely on farmland and smallholder
agriculture for insurance in the absence of a functioning
welfare state.
LChina has failed to fully perform its obligations
under the WTO. It has erected a series of nontariff barriers
that include state trading; excessive domestic subsidies and
stockpiling of commodities; discriminatory taxes; uncalled-for
antidumping duties; and slow approvals of biotechnology
applications for U.S. crops. Damaging to U.S. interests as well
are sanitary and phytosanitary restrictions, especially BSE-
based bans on beef and zero tolerance for ractopamine in pork.
Although China has significantly lowered its tariffs and
increased its agricultural imports since accession, numerous
trade restrictions remain in place.
LU.S. companies, universities, and government
agencies are helping China to improve the quantity and quality
of its food output. In a sign of deepening bilateral ties, the
United States and China signed the first U.S.-China Plan of
Strategic Cooperation in Agriculture (2012-2017) in February
2012, and in March of that year the largest-ever U.S.
agricultural trade mission visited China. However, U.S.
companies operating in China are hamstrung by regulatory
uncertainty, restricted market access, and weak intellectual
property enforcement.
LChina is fostering globally competitive
agribusinesses, in the process becoming an active acquirer of
agricultural assets overseas. In June 2013, China's largest
pork producer, Shuanghui, proposed a $7.1 billion acquisition
of Smithfield, the leading pork producer in the United States.
While the deal has been approved by CFIUS and Smithfield's
shareholders, it raises critical issues regarding net economic
benefits, intellectual property, reciprocal market access, and
the treatment of quasi-private Chinese companies that maintain
links to the Chinese government.
LChina accounts for a large share of the fruits,
vegetables, fish, and processed foods that Americans consume,
but the United States has little assurance that the food
imports coming into the United States from China are safe.
China's own food safety regulation is still ineffective, in
spite of recent efforts to consolidate agencies and improve
legislation. U.S. consumers rely on U.S. food safety inspectors
to do their jobs, but U.S. regulation is also fragmented and
underfunded. U.S. regulators have increased their presence
within China but have struggled to obtain work visas and to
gain access to food production facilities. Although the United
States does not permit raw meat imports from China, the USDA
has granted equivalence status to Chinese poultry processors,
which will permit them to process poultry raised in the United
States and Canada and ship it to the United States.
Chapter 2: China's Impact on U.S. Security Interests
Military and Security Year in Review
China's late 2012 leadership transition brought the largest
turnover to the Central Military Commission (CMC) in a decade.
Xi Jinping assumed the position of both CMC chairman and
Chinese Communist Party (CCP) general secretary at the CCP's
18th Party Congress on November 15, 2012. President Xi then
completed his accession as China's senior leader by becoming
the People's Republic of China (PRC) president on March 14,
2013. Although President Xi was widely expected to eventually
assume all three of China's top leadership posts, many
observers were surprised by the speed of his elevation to CMC
chairman. Mr. Hu broke with the pattern established by his two
predecessors, who retained the CMC chairmanship for two years
after finishing their terms as CCP general secretary.
Since becoming CMC chairman, President Xi has used public
speeches and visits to People's Liberation Army (PLA) units to
reaffirm China's long-term military modernization goals;
emphasize the importance of a strong military to the
fulfillment of the ``China Dream,'' his new political slogan
and party campaign; and signal his intent to focus on
increasing combat readiness and reducing corruption in the PLA.
In November 2012, President Xi introduced the ``China
Dream'' concept, which envisions the ``great renewal of the
Chinese nation'' and the advancement of an international system
in which China's successful rise provides an attractive
alternate political model to Western ones. Achieving the dream
means building a ``moderately prosperous society'' by 2021 and
a ``modern socialist society that is strong, democratic,
cultured, and harmonious'' by 2049. Although President Xi
emphasizes that ``peaceful development'' and a sta-
ble regional environment are essential to create the conditions
for this vision, he linked its fulfillment to a strong military
in a
December 2012 speech while aboard a PLA Navy destroyer. In June
2013, official PLA media explained, ``To the armed forces,
the China dream is the strong-army dream, the China dream leads
the strong-army dream, and the strong-army dream supports the
China dream.''
During his first reported visit to a PLA base as CMC
chairman in December 2012, President Xi called for the PLA to
increase ``combat readiness'' through ``realistic training.''
Combat readiness has been a central theme of subsequent
speeches to the military by President Xi and now features
prominently in official PLA statements and documents. For
example, official PLA media in January 2013 said the military
needs to prevent and overcome the ``harmful'' practice of
training ``for show.'' Furthermore, describing the PLA's 2013
training priorities, a PLA official said: ``The `scent of
gunpowder' in the `fighting' will be stronger. The entire
military will make `training like real war' . . . the main
theme of the entire year's training, powerfully strengthening
training of mission topics, ensuring that as soon as there is a
situation, the military will be able to go forward and fight to
victory.''
In a meeting shortly after becoming the CMC chairman,
President Xi urged senior PLA officers ``to take a firm stand
against corruption'' and to maintain a ``strict work style''
and ``iron discipline.'' Since then, reducing corruption and
waste in the PLA has been one of President Xi's most consistent
messages in his public speeches to the military. In addition to
rhetoric, President Xi has announced stronger anticorruption
regulations for the PLA, including restrictions on military
personnel holding banquets, drinking excessive amounts of
alcohol, and using luxury hotels.
In March 2013, China announced its official defense budget
for 2013 rose 10.7 percent to 720.168 billion RMB
(approximately $117.39 billion), signaling the new leadership's
support for the PLA's ongoing modernization efforts. This
figure represents 5.3 percent of total government outlays and
approximately 1.3 percent of estimated GDP. China's official
annual defense budget now has increased for 22 consecutive
years and more than doubled since 2006. The Institute of
International Strategic Studies assesses China's actual defense
spending is 40 to 50 percent higher than the official figure.
The U.S. Department of Defense (DoD) estimated China's actual
defense spending in 2012 fell between $135 and $215 billion,
which was approximately 20 to 90 percent higher than China's
announced defense budget.
In April 2013, China released the latest version of its
biennial defense white paper. This is the first defense white
paper published since President Xi became CMC chairman.
Although Chinese military leaders likely began to draft the
document before President Xi assumed the position, official
Chinese press suggests it contains strategic priorities
specific to him. Official Chinese media hailed the 2012 defense
white paper as a milestone in transparency, citing the
``declassification'' of military information. However, most of
this was widely-known information that Beijing had never
officially acknowledged. Furthermore, as in previous
iterations, the 2012 defense white paper offers no substantive
information on important defense issues.
Since commissioning its first aircraft carrier, the
Liaoning, in September 2012, the PLA Navy has continued to
develop a fixed-wing carrier aviation capability for air
defense and offensive strike missions. China plans to follow
the Liaoning with at least two indigenously built carriers. The
first likely will enter service by 2020 and the second by 2025.
China's Julang-2 (JL-2) submarine-launched ballistic missile
(SLBM) is expected to reach initial operations capability by
late 2013. The JL-2, when mated with the PLA Navy's JIN-class
nuclear ballistic missile submarine (SSBN), will give China its
first credible sea-based nuclear deterrent. The SLBN/SSBN
weapon system will be able to target the continental United
States from China's littoral waters.
The PLA Navy continues to steadily increase its inventory
of modern submarines and surface combatants. China is known to
be building seven classes of ships simultaneously but may be
constructing additional classes. China also recently began
developing its first sea-based land attack capability. Modern
submarines and surface combatants equipped with land attack
cruise missiles (LACMs) will enhance Beijing's flexibility for
attacking land targets throughout the Western Pacific,
including U.S. facilities in Guam.
China also continues to pursue new space and counterspace
capabilities. In May 2013, China fired a missile into nearly
geosynchronous Earth orbit, marking the highest known
suborbital launch since the U.S. Gravity Probe A in 1976 and
China's highest known suborbital launch to date. Although
Beijing claims the launch was part of a high-altitude
scientific experiment, available data suggest it was intended
to test at least the launch vehicle component of a new high-
altitude antisatellite (ASAT) capability. If the launch is part
of China's ASAT program, Beijing's attempt to disguise it as a
scientific experiment would demonstrate a lack of transparency
about its objectives and activities in space. Furthermore, such
a test would signal China's intent to develop an ASAT
capability to target satellites in an altitude range that
includes U.S. Global Positioning System (GPS) and many U.S.
military and intelligence satellites. Throughout 2013, China
also made significant advances in its manned space and regional
satellite navigation programs. The PLA's extensive role in
China's civilian space programs suggests these activities
support the development of PLA space, counterspace, and
conventional capabilities in addition to serving China's
overall development strategy.
In late January 2013, China conducted the first test flight
of its indigenously developed cargo transport aircraft, the
Yun-20 (Y-20). China previously was unable to build heavy
transports, so it has relied on a handful of Russian aircraft
for strategic airlift since the 1990s. Once large-scale
deliveries of the new plane begin, the Y-20 aircraft will be
able to support a variety of domestic and international
military operations. The Y-20 will enhance the PLA's ability to
respond to internal security crises and border contingencies,
support international peacekeeping and humanitarian assistance
operations, and project power in a regional conflict.
In June 2013, the PLA Air Force began to receive new
Hongzha-6K (H-6K) bomber aircraft. The H-6K has an extended
range and can carry China's new long-range LACM. The bomber/
LACM weapon system provides the PLA Air Force with the ability
to conduct conventional strikes against regional targets
throughout the Western Pacific, including U.S. facilities in
Guam. Although the H-6K airframe could be modified to carry a
nuclear-tipped air-launched LACM, and China's LACMs likely have
the ability to carry a nuclear warhead, there is no evidence to
confirm China is deploying nuclear warheads on any of its air-
launched LACMs.
In July 2013, the PLA began to deploy peacekeepers to the
United Nations (UN) Multidimensional Integrated Stabilization
Mission in Mali (MINUSMA). The PLA contingent includes what
Beijing calls a ``security force'' from a PLA group army. This
marks the first time Beijing has deployed infantry to support a
peacekeeping operation since it began participating in UN
missions in 1990. China previously had limited the PLA's
participation in peacekeeping operations to noncombat troops.
China's Cyber Activities
In 2013, strong evidence emerged that the Chinese
government is directing and executing a large-scale cyber
espionage campaign against the United States. Mandiant, a
private U.S. cybersecurity firm, issued a report that provides
evidence that the PLA since 2006 has penetrated the networks of
at least 141 organizations, including companies, international
organizations, and foreign governments. These organizations are
either located or have headquarters in 15 countries and
represent 20 sectors, from information technology to financial
services. Of the organizations penetrated, 81 percent were
either located in the United States or had U.S.-based
headquarters.
The Mandiant report was followed by DoD's first direct
accusation that the Chinese government and military are
conducting cyber espionage against U.S. networks. DoD's 2013
annual report to Congress on China's military stated: ``In
2012, numerous computer systems around the world, including
those owned by the U.S. government, continued to be targeted
for intrusions, some of which appear to be attributable
directly to the Chinese government and military.'' Previously,
DoD had stopped short of attributing cyber espionage to the
Chinese government or military, instead merely acknowledging
cyber espionage ``originated'' in China.
There are no indications the public exposure of Chinese
cyber espionage in technical detail throughout 2013 has led
China to change its attitude toward the use of cyber espionage
to steal intellectual property and proprietary information. It
is clear naming and attempting to shame will not be sufficient
to deter entities in China from engaging in cyber espionage
against U.S. companies. Mitigating the problem will require a
multifaceted approach. Many potential actions to address the
problem are being discussed by Congress, the Obama
Administration, and outside experts. These actions include
linking economic cyber espionage to trade restrictions,
prohibiting Chinese firms using stolen U.S. intellectual
property from accessing U.S. banks, and banning U.S. travel for
Chinese organizations that are involved with cyber espionage.
To date, Washington has not implemented a comprehensive
framework for addressing China's ongoing cyber espionage.
China's Maritime Disputes
Although sovereignty disputes in the East and South China
Seas are not new, China's growing diplomatic, economic, and
military clout is improving China's ability to assert its
interests. It is increasingly clear that China does not intend
to resolve the disputes through multilateral negotiations or
the application of international laws and adjudicative
processes but instead will use its growing power in support of
coercive tactics that pressure its neighbors to concede to
China's claims. Viewing a public defense of its maritime claims
as central to political legitimacy, leaders in Beijing exploit
deep-seated popular nationalism to support foreign policy aims
in the East and South China Seas. China also views sovereignty
over the East and South China Seas as critical to its national
security, territorial integrity, and economic development.
China has been more assertive since the publication of the
Commission's 2012 Report, offering counterclaimants the choice
of either facing the brunt of Chinese power as a result of
challenging Chinese claims or benefitting from economic and
political rewards for moderating their positions or even
acquiescing to China's claims. Chinese official statements and
use of maritime law enforcement rather than military forces
suggest Beijing prefers to avoid direct military conflict over
its maritime disputes and rely on the shift in the balance of
regional power in its favor to resolve its maritime disputes in
the long term.
The East China Sea dispute involves China, Japan, and
Taiwan. The dispute can be divided into two distinct issues:
territorial sovereignty over the Senkaku Islands (known as the
Diaoyu Dao in China, and Diaoyutai in Taiwan), and demarcation
of maritime zones that have implications for natural resource
rights. Given the historical animosity between China and Japan
and the strong nationalist sentiment on both sides regarding
the sovereignty of the islands, the Senkaku Islands dispute is
especially intense. The Japanese government's September 2012
purchase of three of the islands from a private Japanese owner
angered China, sparking an escalation in tensions between China
and Japan. PLA Navy and Chinese maritime law enforcement
activity near the Senkaku Islands, previously irregular and
sporadic, increased to a robust and near-persistent presence
following Japsn's purchase of the islands. Tensions continued
to simmer throughout 2013 as both sides enhanced their naval
and maritime law enforcement presence in the disputed waters to
assert their claims.
The South China Sea dispute involves China, Taiwan,
Vietnam, the Philippines, Malaysia, and Brunei. Beijing denotes
its claim on its South China Sea maps using a nine-dash line,
with an additional dash off the coast of Taiwan to demonstrate
its sovereignty over Taiwan. China's diplomatic preference on
the South China Sea is to ``divide and conquer'' by negotiating
the issue on a bilateral basis rather than under the auspices
of multilateral forums such as ASEAN.
In addition to boosting its presence in the East and South
China Seas, Beijing has taken a number of steps since mid-2012
to address shortcomings in its coordination of maritime policy
to better align China's maritime activity with national policy.
In an effort to streamline its maritime policy-making
bureaucracies to manage its maritime disputes more effectively,
China created a high-level policy advisory group on maritime
security issues in mid-2012 and consolidated multiple maritime
law enforcement agencies into a single China Coast Guard in
mid-2013.
Beijing discourages and seeks to prevent the diplomatic
involvement of the United States in the East and South China
Seas because Beijing considers these disputes bilateral issues
between China and each claimant. However, U.S. treaty
commitments and forward-deployed military presence bind the
United States to the region in ways that link its security
interests to the peaceful resolution of China's maritime
disputes. Despite a generally improving military-to-military
relationship, mutual mistrust about one another's long-term
intentions continues to pervade the overall security
relationship. This strategic backdrop poses challenges for the
operational environment at sea, especially as the maritime
operating areas of the two countries increasingly overlap.
Conclusions
Military and Security Year in Review
LPLA modernization is altering the security
balance in the Asia Pacific, challenging decades of U.S.
military preeminence in the region.
LThe PLA Navy is in the midst of an impressive
modernization program. China's acquisition of naval platforms,
weapons, and systems has emphasized qualitative improvements,
not quantitative growth, and is centered on improving its
ability to strike opposing ships at sea and operate at greater
distances from the Chinese mainland. Today, the PLA Navy is
able to conduct high-intensity operations in China's immediate
periphery as well as low-intensity operations beyond the
region. Trends in China's defense spending, research and
development, and shipbuilding suggest the PLA Navy will
continue to modernize. By 2020, China could have approximately
60 submarines that able are able to employ submarine-launched
intercontinental ballistic missiles or antiship cruise missiles
and approximately 75 surface combatants that are able to
conduct multiple missions or that have been extensively
upgraded since 1992.
LThe PLA is rapidly expanding and diversifying its
ability to strike U.S. bases, ships, and aircraft throughout
the Asia Pacific region including those that it previously
could not reach, such as U.S. military facilities on Guam.
LThe PLA's expanding involvement in real world
missions allows it to field-test equipment and obtain hands-on
experience in areas such as addressing unconventional threats
in harsh and potentially hostile environments, satisfying
expeditionary logistics requirements, and integrating into
multilateral operations.
LThe PLA is improving its day-to-day readiness
levels and conducting longer-range and more frequent, robust,
and realistic training. As these reforms continue, the PLA will
become more proficient and confident operating its advanced
platforms and weapon systems and better able to rapidly respond
to regional contingencies.
LThe PLA Navy's growing presence in foreign EEZs
contradicts its longstanding policy on military activities in
its own EEZ. Rather than resolve the inconsistency between its
actions and policy, Beijing likely will continue to assert its
authority to regulate U.S. military activities in its EEZ.
China's Cyber Activities
LThe Chinese government is directing and executing
a large-scale cyber espionage campaign against the United
States and to date has successfully targeted the networks of
U.S. government and private organizations, including those of
DoD and private firms. These activities are designed to achieve
a number of broad economic and strategic objectives, such as
gathering intelligence, providing Chinese firms with an
advantage over their competitors worldwide, advancing long-term
research and development objectives, and gaining information
that could enable future military operations.
LChina has not reduced its cyber intrusions
against the United States despite recent public exposure of
Chinese cyber espionage in technical detail. This suggests
Beijing has decided to continue its cyber campaign against the
United States.
LDevelopments in cloud computing in China may
present cybersecurity risks for U.S. users and providers of
cloud computing services. The relationship between China's
Ministry of State Security and the Chongqing Special Cloud
Computing Zone represents a potential espionage threat to
foreign companies that might use cloud computing services
provided from the zone or base operations there. In addition,
the plan to link 21Vianet's data centers in China and
Microsoft's data centers in other countries suggests the
Chinese government one day may be able to access data centers
outside China through Chinese data centers.
LThere is an urgent need for Washington to take
action to prompt Beijing to change its approach to cyberspace
and deter future Chinese cyber theft. Actions and policies
under discussion include the following: passing new legislation
or modifying existing legislation; changing the cost-benefit
calculus of Chinese cyber actors and China's leaders through
sanctions and counterintelligence tactics; undertaking
multilateral measures; appointing a Cabinet-level official to
oversee an interagency process regarding the protection of
intellectual property; and enhancing cooperation between the
U.S. government and the private sector. These would be more
effective if used in combination, as they probably would lead
Beijing to make only temporary or minor changes to its cyber
espionage activities if used in isolation.
China's Maritime Disputes
LChina relies on a coercive and persistent
maritime law enforcement and naval presence to gain control of
disputed territory in the East and South China Seas. A
consolidated maritime policymaking bureaucracy and streamlined
maritime law enforcement fleets could increase Beijing's
confidence in its capability for coercion in the ongoing
maritime disputes.
LTwo key drivers shape China's approach to its
maritime disputes: First, China encourages ardent popular
nationalism, which it exploits to support its foreign policy
aims in the East and South China Seas. Second, China views
sovereignty over claims in the East and South China Seas as
central to its national security, territorial integrity, and
economic development.
LChina uses legal and administrative measures to
assert de jure governance over its disputed maritime regions;
it deploys maritime law enforcement and naval vessels to its
claimed waters to demonstrate and lay the groundwork for de
facto governance.
LBeijing's tendency to demonstrate resolve in its
maritime disputes; its large and complicated political, foreign
affairs, and military bureaucracy; and its inconsistent
adherence to internationally accepted norms of air and maritime
operations may contribute to operational miscalculations in the
East and South China Seas. Unyielding positions on sovereignty
and nationalist sentiment surrounding these maritime disputes
increase the risk of escalation from a miscalculation at sea to
a political crisis.
Chapter 3: China and the World
China and the Middle East and North Africa
China employs a multifaceted foreign policy approach to the
Middle East and North Africa (MENA). It is characterized by
growing economic (and particularly energy) ties; the pursuit of
friendly relations with all countries (as well as the
Palestinian territories) in the region; the protection of
domestic stability and control in China; and the promotion of
regional stability in support of China's own domestic economic,
political, and security priorities. China has in recent years
faced challenges in the region, particularly in responding to
political upheaval and regime changes during and after the Arab
Spring. China also has taken positions in support of regimes in
Syria and Iran that put it at odds with the United States and
other regional and international communities.
China is expanding and deepening its trade and investment
ties with countries in the region. Between 2003 and 2012,
China-MENA annual trade increased more than twelvefold, from
$20.8 billion to $262.1 billion. In 2009, China overtook the
United States to become the world's largest exporter to the
region. China's energy demand is the primary driver of these
economic ties. MENA accounts for more than 50 percent of
China's crude oil imports; these imports are projected to grow
in the coming decades. China's leaders view the country's
growing reliance on MENA oil imports as a strategic
vulnerability. This sense of vulnerability appears to drive
Beijing's efforts to enhance the security of its imports by
strengthening its relations with the region's largest oil
producers, particularly Saudi Arabia and Iran, but also Iraq,
Oman, and others.
China seeks to develop and maintain friendly ties with all
MENA countries without being drawn into the region's conflicts
and power struggles. As such, China has more or less
successfully maintained positive relationships with the major
powers in the region, simultaneously strengthening ties with
regional rivals like Israel and Iran, Saudi Arabia and Iran,
and the Israelis and Palestinians. Beijing's approach generally
has been well-received in the region, where China enjoys mainly
positive views among leaders and the public.
China also seeks to leverage its relations in MENA in
support of its own domestic security, particularly in the
Xinjiang Uighur Autonomous Region, home to many of China's
ethnic Turkic Muslims. Episodic ethnic and political unrest in
Xinjiang has in the past attracted support from overseas Muslim
groups in MENA. Beijing fears these overseas groups could
encourage or exacerbate what it refers to as ``separatist
insurgencies'' in Xinjiang. To mitigate this perceived risk,
China solicits support from countries in the region for its
policies to suppress ``separatist'' activities in Xinjiang.
In addition, China has taken steps to promote stability
within MENA. Offers of support for the Israeli-Palestinian
peace process, counterpiracy operations in the Gulf of Aden,
and participation in UN peacekeeping operations in MENA are
among China's contributions to regional security and stability.
However, China also has undermined security in the region with
its support for the Assad regime in Syria and its continued
economic and political ties to Iran.
As China's interests and presence in MENA grow, they
inevitably will impact U.S. objectives and influence. Although
Beijing has in the past avoided directly opposing Washington on
issues related to MENA, this appears to be changing. Beijing's
relationship with Tehran and its position on the Syrian
conflict seem to indicate that, when key interests are at
stake, China is willing to challenge the United States.
Taiwan
Cross-Strait economic ties continue to expand and deepen.
From January through July 2013 (the most recent months for
which official statistics are available), the total value of
trade between China and Taiwan was $71.8 billion. The total
value of cross-Strait trade during this period grew by 2.79
percent compared to the same period in 2012. Through the first
seven months of 2013, China remained Taiwan's largest export
market, accounting for approximately $47.3 billion worth of
exports (26.9 percent of Taiwan's total exports). China
followed behind Japan as Taiwan's second-largest source of
imports, accounting for approximately $24.5 billion worth of
imports (15.5 percent of Taiwan's total imports). Although
China remained the top destination for Taiwan FDI in 2012,
Taiwan's approval of $10.9 billion in investments in China in
2012 represented a 16.6 percent decrease from the previous year
and a three-year low. From January through July 2013, the value
of Taiwan FDI to China continued to decrease, slipping 17.23
percent from the previous year. Officials at the American
Institute in Taiwan (AIT), which serves as the de facto U.S.
embassy in Taiwan, told the Commission that Taiwan businesses
increasingly are looking for investment opportunities in
Southeast Asia, Africa, and Latin America as manufacturing
costs in China continue to rise. Mainland investment in Taiwan
continued to grow in the first seven months of 2013, with the
value of investments increasing 79.34 percent compared to the
same period in 2012.
In 2013, Taiwan used creative diplomacy to secure
participation in a key international organization and to sign
two free trade agreements despite China's continued efforts to
restrict Taiwan's full participation in the international
community. The president of the UN's International Civil
Aviation Organization (ICAO) in September 2013 invited a Taiwan
delegation to attend the upcoming ICAO assembly as his
``guests.'' Furthermore, Taiwan and New Zealand signed a free
trade agreement in July 2013, which marks Taiwan's first such
deal with a country with which it does not have official
diplomatic relations; Taiwan and Singapore agreed in principle
to a free trade agreement in May 2013; and Taiwan is
participating in negotiations with 22 other WTO members,
including the United States, on a multilateral Trade in
Services Agreement. Taiwan's Ministry of Economic Affairs told
the Commission that Taiwan's efforts to expand its trade ties
with the Asia Pacific region are part of Taiwan President Ma
Ying-jeou's larger push to diversify Taiwan's economic partners
to avoid overreliance on China. Other Taiwan officials
explained to the Commission that the agreements will help
promote Taiwan's inclusion in Asia's broader economic
integration, including participation in multilateral trade
pacts such as the Trans-Pacific Partnership and the Regional
Comprehensive Economic Partnership.
In April 2013, Taiwan and Japan signed a fisheries
agreement after 17 years of intermittent negotiations.
President Ma said the agreement demonstrates Taiwan's
constructive role in reducing tension in the East China Sea
without compromising Taiwan's maritime claims and could be used
as a blueprint and impetus for a similar agreement between
Taiwan and other countries with claims in the South China Sea.
In March 2013, the Philippine Coast Guard opened fire on a
Taiwan fishing boat operating in disputed waters in the South
China Sea, resulting in the death of a Taiwan fisherman and
sparking a diplomatic row with Taiwan. Manila and Taipei both
assert the incident took place within their respective
exclusive economic zones in the South China Sea. After Taiwan
claimed that the Philippines failed to adequately address its
demands in the aftermath of the shooting, Taiwan stopped
accepting new Filipino labor applications; suspended trade,
fishery, and technology exchanges with the Philippines; and
removed the Philippines from Taiwan's visa waiver program.
Taiwan removed the sanctions in August after the Philippines
offered an official apology on behalf of the Philippine
president, agreed to pay compensation to the victim's family,
and recommended homicide charges for the Philippine Coast Guard
personnel who opened fire on the Taiwan fishing boat. Taiwan
and the Philippines also are discussing measures to reduce the
risk of future incidents and working to establish a bilateral
fisheries mechanism.
Taiwan's ability to defend against China's growing military
capabilities is declining. The key shortcoming in Taiwan's
defensive capabilities is its inability to survive initial
Chinese air and missile strikes due to insufficient
infrastructure hardening and lack of mobile systems. China's
overwhelming quantitative and qualitative advantage over Taiwan
also will challenge the Taiwan military's ability to sustain
high-intensity operations during a conflict. Nevertheless,
Taiwan's defense budget continues to decline. Taiwan's official
defense budget contracted to $10.5 billion in 2013 from $10.6
billion in 2012. Taiwan's 2013 defense spending represents 2.1
percent of its GDP, a record low matched only in 2006 and 2011.
This is less than 3 percent of GDP--the level at which
President Ma pledged to maintain defense spending--and marks a
substantial decrease from 3.8 percent of GDP in 1994. In
response to concerns about Taiwan's declining defense budget
relative to GDP, President Ma has explained defense spending
cannot be expected to keep pace with Taiwan's GDP growth.
Taiwan's GDP growth rate was 10.7 percent in 2010, 4 percent in
2011, and 1.3 percent in 2012.
Despite warming cross-Strait ties, China continues to
engage in aggressive espionage activities against Taiwan. Since
September 2012, Taiwan has arrested at least six former or
active Taiwan military officers, including one flag officer,
for espionage. In one case, a former Taiwan Navy officer may
have provided to China classified submarine nautical charts as
well as hydrographic information about the waters surrounding
Taiwan. These cases underscore the breadth and depth of China's
espionage activities against Taiwan and highlight the
increasing counterintelligence risks to Taiwan and U.S.
military information shared with Taiwan.
The recent cross-Strait rapprochement benefits the United
States by reducing the likelihood of a U.S.-China conflict over
Taiwan; contributing to peace, prosperity, and stability in
East Asia; and allowing U.S. policymakers to focus their time
and attention on other priorities in the U.S.-China and U.S.-
Taiwan relationships. At the same time, warming ties between
China and Taiwan raise concerns for Washington and Taipei.
Increasing cross-Strait economic integration will continue to
tie Taiwan closer to China. This could strengthen China's
bargaining power over Taiwan and allow China to make progress
toward its long-term goal of unification. Responding to these
concerns, officials from Taiwan's National Security Council
insisted to the Commission that Taipei's economic engagement
with Beijing is carefully calibrated to promote both Taiwan's
economic growth and continued autonomy.
Macau
The gaming sector is the most important element of the
Macau Special Administrative Region (SAR) economy and is the
highest-grossing gambling location in the world. Tax
collections from the gaming sector in 2012 totaled $13.9
billion, which accounted for 87.5 percent of total government
revenue. Macau's casino-oriented economy and its proximity to
the PRC present a significant risk of money laundering. The
main channel for money laundering is in the gaming sector
through underregulated junket operators and their affiliates,
which include the underground banking system that supports
their operations.
Junket operators in Macau are significantly more involved
in gambling operations than is common throughout the world,
operating with far fewer restrictions. Macau's independent
junket operators and independent VIP rooms are not subject to
the same regulatory requirements as casinos. There is a risk of
money laundering within the independent VIP gaming room
operations which are physically conducted within the casinos
but can remain outside of the casino's official oversight. The
risk is enhanced because so much of the money that is wagered
in Macau goes through the loosely regulated independent VIP
rooms. In 2012, VIP baccarat rooms in Macau casinos accounted
for 69.3 percent of total revenue from games of chance.
A 2007 evaluation by the Financial Action Task Force
recognized the risk of money laundering in Macau's gaming
sector and noted multiple deficiencies in its anti-money-
laundering and counter-terrorist-financing framework. The
evaluation also discovered several specific deficiencies in
Macau's compliance with the Financial Action Task Force
recommendations, including the refusal to respond to foreign
requests to freeze assets, the inability to effectively
implement UN Security Council resolutions on the financing of
terrorism, and the inability of Macau's Customs Service to
investigate money-laundering cases.
Since the report was published in 2007, there remain
significant vulnerabilities with unlicensed junket operators
and the junket affiliates that play an integral role in Macau's
gaming system. Macau's junket operators are not subject to the
same transparency requirements as casinos, and strict privacy
controls prevent U.S. regulators from obtaining information on
individuals operating in Macau subsidiaries of U.S. parent
casinos. The Macau SAR Gaming Inspection and Coordination
Bureau, Macau's gaming regulator, does not disclose financial
information. The lack of information presents difficulties in
determining the origin of money flowing through such
operations, and U.S. state regulators do not have the authority
or resources to independently conduct investigations in Macau
or other foreign jurisdictions.
The PRC's capital controls have caused more money to cycle
through Macau due to Macau's thriving VIP gaming industry,
which relies on junket operators and their affiliates to
facilitate cross-border money transfers for clients via
underground banks. However, Beijing is beginning to take some
measures to restrict illicit cross-border transfers and money
laundering in Macau as part of the nationwide crackdown on
corruption promoted by PRC President Xi.
Hong Kong
The most significant problem for democratic rights
activists is the Hong Kong government's lack of progress toward
ensuring universal suffrage in the election of the Legislative
Council and the chief executive (Hong Kong's highest office).
At present, the chief executive is chosen from a slate of
nominees by a 1,200-person election committee. The Basic Law
states that the ultimate aim for chief executive elections is
through universal suffrage, and current Chief Executive Leung
Chun-ying (CY Leung) has indicated that the city is working
toward this goal. In March 2013, Chief Executive Leung said in
meetings with Chinese President Xi that he was committed to the
process of achieving universal suffrage in Hong Kong by 2017.
In July he also promised free and open elections for the
Legislative Council by 2020.
Despite these stated goals, the dominance of the Hong Kong
government by politicians allied to Beijing has stymied
progress in achieving universal suffrage. The current election
committee is heavily populated with business figures as well as
politicians and labor leaders with strong connections to
Beijing, giving it a distinctly pro-Beijing slant. Beijing
effectively controls roughly 950 of the 1,200 election
committee votes for chief executive. Currently, 30 members of
the 70-person Legislative Council are elected by traditional
functional constituencies, in which professionals in specific
fields such as insurance, transportation, health care, finance,
and tourism are allowed to cast a vote in addition to their
vote in their geographic constituency. The greater
representation of some segments of society as a result of the
functional constituencies, combined with the dominant support
for pro-Beijing candidates among functional constituency
voters, ensures that the Legislative Council remains controlled
by pro-Beijing representatives.
Between 2005-2012, Hong Kong's Freedom House ranking for
press freedom fell from a status of ``free'' to ``partly
free.'' The Hong Kong press itself reports a sense of
diminishing freedom. Following the election of Mr. Leung to
chief executive in 2012, press freedom advocates reported an
escalation in government efforts to censor and control media
access to official information. Free press advocates contend
that the government has reduced the number of full press
conferences it holds for Hong Kong media, thereby denying
journalists the opportunity to ask questions. Media self-
censorship is also a pervasive concern. A poll conducted in May
2013 by the Public Opinion Program of the University of Hong
Kong found that 48 percent of respondents believed that the
local news media practiced self-censorship. Self-censorship has
increased as the Chinese central government has co-opted media
company owners. According to the 2013 annual report of the Hong
Kong Journalists Association, roughly 50 percent of Hong Kong
media owners have been appointed to the National People's
Congress or the Chinese People's Political Consultative
Conference.
Newly proposed legislation would further limit journalists.
An antistalking bill that may be considered this year could
hinder journalists' ability to seek out information from
sources. Another law would limit personal data that corporate
directors must make public. While supporters argue that this
law is important for enhancing protections of individual
personal data, detractors are concerned that it will unduly
shield directors from media scrutiny.
Police surveillance is also a growing concern in Hong Kong.
The 2006 posthandover Interception of the Communications and
Surveillance Ordinance granted police broader and more explicit
authority to conduct physical and communications surveillance
for the sake of public security. The introduction of police
cameras comes at a time when protests against the Hong Kong
leadership are up sharply. In addition to the Occupy Central
efforts and the rallies against the national education
proposal, thousands of Hong Kong residents have participated in
protests calling for the resignation of Chief Executive Leung.
Pan-Democratic legislators meeting with Commissioners in Hong
Kong reported that police are now monitoring and arresting
prodemocracy demonstrators as much as 12 to 24 months after
their participation in political events. In July 2013, for
example, Yau Ka-yu was reportedly arrested and charged with
illegal assembly in relation to her 15-month-old participation
in an April 2012 protest outside the China Liaison Office in
Hong Kong.
Conclusions
China and the Middle East and North Africa
LChina is expanding and deepening its trade and
investment ties with countries in MENA. More than half of
China's crude oil imports are from MENA producers, and China
increasingly looks to the region as an export market for
manufactured goods and services.
LEnergy security is a key driver of China's
engagement in MENA. As China's continued economic growth
becomes more dependent on a steady supply of oil and natural
gas from the region, Beijing likely will augment already robust
economic ties with stronger political and security engagement.
LChina, driven primarily by its growing demand for
energy, seeks to promote a framework for stability in MENA that
supports its own economic, political, and security interests.
These efforts include supporting the resolution of the Israeli-
Palestinian conflict, conducting counterpiracy operations, and
participating in UN peacekeeping missions. Conversely, China's
position on the Syrian conflict and its support for Iran
undermine peace and stability in the region.
LChina struggled to diplomatically adapt to regime
changes across MENA during and after the Arab Spring. Beijing's
instinct has been to support sitting regimes in Egypt, Libya,
and Syria and to oppose international intervention in these
countries.
LMost MENA governments appear to judge China plays
a positive role in the region. Oil- and natural gas-producing
states in particular look to China as their future primary
market. Moreover, governments in China and some MENA countries
appear to share similar stances on issues of sovereignty, human
rights and democracy, and the role of the state in the economy.
However, many MENA countries have criticized China for its
support for the Assad regime in Syria.
LHistorically, China largely has avoided
challenging U.S. influence and power in the Middle East. In
recent years, however, when key Chinese interests are at stake,
China has made use of its permanent membership in the UN
Security Council to oppose U.S. policies and objectives in the
region.
Taiwan
LCross-Strait economic, cultural, and educational
ties continue to expand and deepen. However, domestic political
dynamics and priorities in China and Taiwan still constrain
movement on political and security issues.
LSince the Commission's 2012 report, Taiwan has
used creative diplomacy to sign two free trade agreements and
secure participation in a key international organization.
Taiwan's expanding international space helps the country
counterbalance its economic reliance on China by increasing its
competitiveness in the world economy, raises the cost to
Beijing of military coercion against Taiwan, and promotes
regional stability.
LPresident Ma since his reelection in January 2012
has accelerated efforts to increase Taiwan's economic
engagement with the United States and gain U.S. support for
expanding Taiwan's international space, while continuing to
advocate for future U.S. arms sales.
LTaiwan's military over the last decade has
improved its ability to conduct joint operations and has
developed some asymmetric capabilities. However, China's rapid
military modernization during this time has outpaced these
improvements and negated many of the military advantages Taiwan
previously held over China.
Macau and Hong Kong
LThe rapid inflow of money to Macau, its casino-
oriented economy, and its proximity to the PRC present a
significant risk of money laundering and financing of
terrorism, particularly in the underregulated shadow banking
and junket system supporting the VIP gaming business in Macau.
LA combination of the PRC's strict capital
controls and restrictions on the collection of gambling debts
has given rise to grey market alternatives to facilitate the
movement of gambling funds into Macau. Gambling debt collection
conducted by unregulated third-party affiliates in the Mainland
is susceptible to organized crime and violence.
LMacau's junkets with alleged criminal
affiliations present legal risks for U.S.-licensed casinos
operating VIP rooms in Macau. Casinos found to be working with
junkets directly or indirectly associated with Asian organized
crime may be subject to revocation of their state-issued
license to operate in the United States.
LMacau's loose regulation of the junket system and
its strict privacy law prevent U.S. regulators from accessing
information they are accustomed to, and U.S. state regulators
lack the authority and resources to independently conduct
investigations in foreign jurisdictions. This prevents U.S.
regulators from accurately accessing the situation in Macau and
effectively stops them from evaluating individuals conducting
business with U.S.-licensed casinos.
LMacau's anti-money-laundering and counter-
terrorist-financing framework has fallen short in complying
with internationally recognized standards. Numerous
vulnerabilities remain in its regulations, including
deficiencies relating to Macau's inability to effectively
freeze financial assets and its inadequate inspection and
oversight of casinos and junket operators and promoters.
LDespite reports that the PRC aims to more closely
monitor Macau's gaming industry as part of its nationwide
initiative to crack down on corruption, there is no substantial
evidence to suggest that Beijing intends a crackdown on illicit
money transfers and money laundering in Macau.
LTo protect their licenses to do business in the
United States, American casinos have adopted a number of
measures designed to prevent illegal activities in their VIP
rooms. The Commission is not in a position to evaluate whether
those measures are fully adequate to insulate the operations of
those rooms from illegal activity.
LDespite official statements of support from
Beijing and the Hong Kong chief executive, the continued lack
of meaningful progress calls into question Beijing's real
intentions. Prospects for universal suffrage by 2017 are
dimming. Political interference, government restraints on
access to information, and self-censorship continue to take a
toll on press freedom in Hong Kong. Public perceptions of media
credibility have declined since the handover. Violent attacks
on prodemocracy news outlets and their owners are on the rise,
and the totality of the evidence suggests that Beijing does not
intend to allow real democracy to develop in Hong Kong.
LProdemocracy activists express alarm over
stepped-up police surveillance at protests, which they fear may
be aimed at chilling public discourse or quelling public
dissent.
LAll of these trends run counter to the Basic
Law's assurances that Hong Kong's traditional democratic and
civil rights would be preserved for the first 50 years
following the handover.
LThe systematic disenfranchisement of those who
support greater democratic freedoms and civil liberties has
created a climate of political polarization that may undermine
Hong Kong's fundamental governability.
THE COMMISSION'S KEY RECOMMENDATIONS
The Commission believes that ten of its 41 recommendations
to Congress are of particular significance. The complete list
of recommendations appears at the Report's conclusion on page
397.
The Commission recommends:
LCongress fund the U.S. Navy's shipbuilding and
operational efforts to increase its presence in the Asia
Pacific to at least 60 ships and rebalance homeports to 60
percent in the region by 2020 so that the United States will
have the capacity to maintain readiness and presence in the
Western Pacific, offset China's growing military capabilities,
and surge naval assets in the event of a contingency.
LCongress ensure that the Food and Drug
Administration (FDA) makes it a priority to increase the number
of physical inspections of Chinese food imports at the border;
to increase the rigor of those inspections to include testing
for pathogens and chemical, pesticide, and drug residues, and
processed food ingredients; and to conduct more frequent and
thorough inspections in food facilities in China. Congress
should also urge the U.S. Department of Agriculture (USDA) to
permanently assign inspection personnel to China so that the
exporting plants receive regular visits by USDA inspectors.
LCongress direct the Department of Commerce to
develop a comprehensive, ongoing inventory of Chinese foreign
direct investment (FDI) in the United States and, on an annual
basis, update the inventory. The inventory should identify the
ownership structure of the entity engaging in the investment.
In preparing the inventory, the department should call on
private sector entities engaged in monitoring Chinese
investments in the United States and such other entities to
ensure that its report is complete and accurate. The department
should prepare a comprehensive report to Congress on an annual
basis identifying the FDI by Chinese entities that were made in
the previous calendar year. In its report, the department
should indicate those investments that received any assistance
from the ``Select USA'' program. The department should also
identify, on an ongoing basis, the lines of commerce that each
of the investments are engaged in.
LCongress direct the Administration to prepare an
inventory of existing federal use of cloud computing platforms
and services and determine where the data storage and computing
services are geographically located. Such inventory should be
prepared annually and reported to the appropriate committees of
jurisdiction.
LCongress assess whether to amend the Committee on
Foreign Investment in the United States (CFIUS) statute to
allow review of greenfield investments for threats to U.S.
national security.
LCongress require the USDA and the U.S. Trade
Representative (USTR) to conduct a comprehensive review of
China's agricultural subsidies, discriminatory taxes, state
trading, and procurement practices; take account of the damages
incurred by U.S. farmers and downstream industries; and suggest
appropriate remedies.
LCongress fund departments of Defense and State
efforts to improve the air and maritime capabilities of U.S.
partners and allies in Asia, particularly with regard to
intelligence, surveillance, and reconnaissance, to improve
maritime domain awareness in the East and South China Seas.
LCongress assess the extent to which existing laws
provide for inadequate or ineffective remedies against the
anticompetitive actions of Chinese state-owned or state-
invested enterprises operating in the U.S. market. Additional
remedies may be required to account for the fact that these
enterprises may not be operating based on commercial
considerations.
LCongress empower the Securities and Exchange
Commission (SEC) to set minimum standards for companies listing
and maintaining listings on U.S. exchanges and enable the SEC
to directly delist foreign companies not in compliance with
these standards.
LCongress urge the Administration to expedite
progress in its implementation of Section 806 of the National
Defense Authorization Act for Fiscal Year 2011 (Public Law 111-
383), which was intended to enhance the Department of Defense's
ability to address supply chain risks.
INTRODUCTION
While 2013 has been a year of leadership change for China,
it is too early to say that the initial economic policy
pronouncements will lead to quick reforms. Less heralded but
longstanding and continuing improvements in China's military
capabilities, however, could have a major impact on the region.
The Chinese leadership accomplished a peaceful turnover
during the past year, complicated by factional political
maneuvering. The handoff for the new five-year term took place
with both ceremony and caution. In the absence of immediate
policy changes from the newcomers, the government in Beijing
coasted on the momentum from the previous decade. While China's
economy slowed from a 30-year double-digit sprint to a more
sustainable pace of 7.66 percent growth, Beijing's new economic
policymakers appear to be clinging to the old formula of
exports and infrastructure projects and a strong state-
controlled sector to boost employment and maintain the regime's
political control.
The Chinese renminbi continued to appreciate against the
dollar but remains undervalued. The rise in the Chinese
currency did not jeopardize China's expanding trade surplus
with the United States nor its growing foreign exchange
reserves, which hit $3.66 trillion at the end of September.
China's new leaders, President and Party General Secretary Xi
Jinping and Premier and Party Secretary of the State Council Li
Keqiang, reaffirmed the government's long-promised goal of
shifting the economy to one more driven by domestic
consumption. However, the major market-based tools and reforms
that China could use to empower Chinese workers and consumers
remain unused: opening China's financial services sector to
foreign investment; shrinking the size and number of state-
owned enterprises; and expanding opportunities for private
investment and savings beyond low interest-bearing deposits in
state-owned banks or risky speculation in the volatile real
estate market. Such moves by China would help reduce the
growing trade imbalance with the United States and boost
employment in America.
Also troublesome were the press reports in April 2013 of an
official but secret party-approved directive known as
``Document No. 9'' that seeks to enhance party authority.
Widely attributed to President Xi, the memo lists seven perils
to be avoided, among them ``Western constitutional democracy,''
``universal values'' of human rights, press freedom and
independence from the government, pro-market ``neo
liberalism,'' an independent judiciary, and ``nihilist''
criticisms of the Chinese Communist Party.
U.S. companies investing in China reported the same problem
areas as the year before. In a survey of the top ten problems
experienced by the foreign affiliates of U.S. companies, the
majority were of the Chinese government's making. U.S.
companies cited competition with Chinese government-owned
companies, onerous licensing procedures, lax intellectual
property protections, discriminatory laws and standards, and
restrictions on foreign investment.
After announcing with some fanfare a free trade zone in
Shanghai, Beijing diluted its potential impact by exempting
segments of 18 different sectors, such as construction,
finance, and manufacturing, from foreign investment and
imposing a variety of other restrictions, highlighting
continued disputes within the government over the pace and
direction of economic reform. Beijing's leadership also reacted
haltingly to the emerging problems in China's lightly regulated
shadow banking system, particularly the buildup of unsecured,
off-balance sheet loans. The system has proliferated because
China's state-owned banking system still heavily favors
government-run enterprises over the efforts of Chinese
entrepreneurs and small- and medium-sized business owners.
Without fundamental banking reform and expanded credit to
private industry and consumers, China's goal of economic
diversification will remain stuck in low gear.
One positive development in bilateral trade has been
agriculture, the only sector in which the United States enjoys
a substantial trade surplus with China. U.S. food producers
stand to benefit from China's growing demand for consumer
foods, especially meat products. But at present, China
concentrates its imports on lower value-added bulk commodities
while exporting consumer foods to the United States that pose
significant safety risks.
Under its new political leadership, China's actions in the
East and South China Seas continued to increase tensions in the
region. It is becoming clear China does not intend to resolve
its maritime disputes through multilateral negotiations or the
application of international laws and adjudicative processes
but prefers to use its growing power in support of coercive
tactics that pressure its neighbors to concede China's claims.
Since the Commission's 2012 Report, strong evidence has
emerged that the Chinese government is directing and executing
a large-scale cyber espionage campaign against the United
States. China to date has compromised a range of U.S. networks,
including those of the Department of Defense and private
enterprises. These activities are designed to achieve a number
of China's broad security, political, and economic objectives,
such as gathering intelligence, providing Chinese firms with an
advantage over their competitors worldwide, advancing long-term
research and development objectives, and gaining information
that could enable future military operations.
Meanwhile, China continued to develop and field advanced
military platforms and weapon systems. China's comprehensive
military modernization is altering the balance of power in the
Asia Pacific, challenging decades of U.S. military preeminence
in the region.
China in 2013 expanded and diversified its arsenal of
weapon systems capable of placing U.S. ships, aircraft, and
bases in the Western Pacific at risk. The People's Liberation
Army (PLA) also continued to pursue cyber, electronic warfare,
and counterspace capabilities that will enable Beijing to
degrade or disrupt the command, control, communications,
computers, intelligence, surveillance, and reconnaissance that
are essential to U.S. military power projection on behalf of
its interests in the region. As these capabilities mature, the
costs and risks to the United States of intervention in a
potential regional conflict involving China will increase.
Furthermore, the PLA enhanced its regional power projection
capabilities, improving Beijing's ability to use force against
Taiwan, Japan, and rival claimants in the South China Sea. This
could increase China's willingness to respond militarily to a
perceived provocation or to consider preemptive attacks in a
crisis involving Taiwan or China's maritime sovereignty claims.
Many of these scenarios could require the U.S. military to
protect U.S. regional allies and partners as well as to
maintain open and secure access to the air and maritime commons
in the Western Pacific.
Most Asian countries welcomed the U.S. rebalance to Asia
when it was announced by the Obama Administration in 2011.
However, there is growing concern among U.S. allies and
partners that the Department of Defense will be unable to
follow through on its commitment to the rebalance due to
declining defense budgets and continuing security challenges
elsewhere.
The Commission's Report addresses these and other issues in
depth as it continues to monitor the evolving economic and
security relationship between our two countries.
CHAPTER 1
THE U.S.-CHINA TRADE
AND ECONOMIC RELATIONSHIP
SECTION 1: TRADE AND ECONOMICS
YEAR IN REVIEW
Introduction
China's economy grew at a 7.66 percent annualized rate in
the first three quarters of 2013, continuing a three-year trend
of decelerating output (see figure 1). This marked a
significant decline from the three decades of growth in the
1980s, 1990s, and 2000s averaging 10 percent annually. Demand
for China's exports stalled, and the domestic economy adjusted
to a drop in government spending on massive infrastructure
projects--undermining the two main pillars of China's economic
surge over the previous decade.* The slowing of the world's
second-largest economy rippled through much of the world,
hobbling the economies of commodity-exporting countries. While
the economic slowdown matched the central government's stated
numerical target for growth, the change was not necessarily the
result of a deliberate government policy. Rather, China's
growth decline largely stemmed from the effects of a
government-induced credit crunch, a precipitous drop in
manufacturing, volatility in banking and real estate, a
declining rate of growth in household incomes, the strain of
meeting interest payments on a growing debt burden, and
uncertainty about the new government's direction after a once-
a-decade leadership transition. This section will explore the
factors behind China's changing economy, the evolution of
China's economic policy, and their implications for the United
States.
---------------------------------------------------------------------------
* During the decade that ended with 2011, China's share of global
exports rose from 7 percent to 21 percent. James R. Hagerty, ``U.S.
Manufacturers Gain Ground,'' Wall Street Journal, August 18, 2013.
http://online.wsj.com/article/
SB1000-1-4-2-4-1-2-7-8-8-7-3-2-3-4-2-3-8-0-4-5-7-9-0-2-0-7-3-2-6-6-1-0-9
-2434.-html#printMode.
Figure 1: China's Quarterly Gross Domestic Product (GDP) Growth,
2009Q1-2013Q3
(percent year-on-year growth, real terms)
Source: China National Bureau of Statistics, via Trading Economics.
http://www.tradingeconomics.com/china/gdp-growth-annual
In order to rebalance the domestic economy, Chinese
policymakers say they intend to raise household income and
consumption, but the past year saw limited progress on this
front. In urban areas, growth in disposable income, the measure
of personal income minus taxes, fell to its lowest levels since
the global financial crisis, suggesting that urban wages did
not rise at the same rate as in previous years. Urban
households, which have very high savings rates, thus had less
capacity to raise their consumption expenditure (see figure
2).\1\ Growth in Chinese retail sales slowed, and the share of
the economy represented by consumer spending declined in the
first half of 2013 compared to the same period in 2012. As a
share of gross domestic product (GDP), China's domestic
consumption remained half that of the United States--following
an established pattern.\2\
Figure 2: Urban Household Disposable Income Growth, 2008-2013Q2
(quarterly, percent year-on-year growth)
Source: China National Bureau of Statistics, via CEIC database.\3\
In China's repressed financial system, households still
deposit the bulk of their savings in low-yielding bank
accounts. According to estimates from the investment bank
Nomura, China's household debt was only 20 percent of GDP last
year, compared to 86 percent in the United States. Still,
China's debt burden increased from 121 percent to 155 percent
of GDP in 2008-2012--a rapid build-up similar to the United
States before the subprime mortgage crisis. Given the explosion
of China's shadow banking sector, actual debt levels are likely
even higher. Debt is concentrated not among households, but
among state-owned industrial enterprises, government-backed
property developers, and local governments. The debt-to-asset
ratio of property developers, for example, increased from 40
percent to 71 percent in 2009-2012. Unlike the United States,
China's households act as net lenders to the rest of the
economy, subsidizing the state sector with easy credit.*
---------------------------------------------------------------------------
* In the United States prior to the subprime mortgage crisis, the
overall debt ratio rose by 30 percentage points of GDP, from 214
percent in 2003 to 244 percent in 2007. Zhang Zhiwei and Wendy Chen,
``China: Rising Risks of a Financial Crisis'' (Hong Kong, China: Nomura
International (Hong Kong) Limited, March 15, 2013), pp.4-7; Federal
Reserve Bank of St. Louis, ``Household Debt to GDP for United States''
(St. Louis, Missouri: October 2013). http://research.-stlouisfed.org/
fred2/series/HDTGPDUSQ163N; Tom Orlik, ``Debt Binge Threatens China
Growth,'' Wall Street Journal, August 27, 2013, p. c1. http://
online.wsj.com/article/
SB1000-1-4-2-4-1-2-7-8-8-7-3-2-4-9-0-6-3-0-4-5-7-9-0-3-6-592255182758.ht
ml.
---------------------------------------------------------------------------
Chinese leaders vow to deemphasize exports as a source of
income. Export growth in China has slowed as demand in much of
the world dropped, though not enough to correct the country's
external imbalances. China still sends five dollars' worth of
goods to the United States for every dollar in U.S. imports. In
2012, the U.S. deficit with China in goods reached $315
billion--the highest on record. In July 2013, China's monthly
bilateral surplus with the United States surpassed $30 billion
for the first time.\4\ China's vast current account surplus,
coupled with restrictions on its capital accounts and exchange
rate, has caused the central bank to accumulate foreign
currency reserves exceeding $3.66 trillion, by far the largest
in the world.
Leadership Transition and Economic Policy
In the spring of 2013, Xi Jinping became president of the
People's Republic of China (PRC). Li Keqiang, in turn, was
appointed the premier and Communist Party secretary of the
State Council, China's cabinet. No prominent political or
economic reformers were elevated to the Politburo Standing
Committee, China's highest decision-making body, though the
backgrounds of Wang Qishan and Zhang Gaoli * suggest that they
might be open to further economic reform.\5\ Proteges of former
PRC President Jiang Zemin captured more spots than the allies
of former President Hu Jintao (the sole protege of Hu Jintao on
the Standing Committee is Premier Li Keqiang). Although
Jiang Zemin's era is associated with more economic reform than
the subsequent Hu Jintao period, when many reforms were rolled
back,= there are few signs of a renewed push for reform. (For
coverage of the leadership change relating to foreign policy
and military matters, please see chap. 2, sec. 1, of this
Report.)
---------------------------------------------------------------------------
* Zhang Gaoli was appointed the PRC executive vice premier (Wang
Qishan was widely expected to be appointed to this position), in charge
of economics and domestic policy. Mr. Zhang has extensive leadership
experience in economically advanced regions (Shenzhen, Shandong, and
Tianjin), but he has kept a low profile, and his views on further
reform are unclear.
For a more detailed assessment of China's new leadership
lineup, see John Dotson, The China Rising Leaders Project, Part 2:
Outcomes of the Chinese Communist Party's 18th National Congress
(Washington, DC: U.S.-China Economic and Security Review Commission,
Decem-
ber 21, 2012), pp. 19-20. http://origin.www.uscc.gov/sites/default/
files/Research/18th-CCP----Party-Congress----Overview.pdf.
= The state sector has prospered in the past decade, with
financing, market access, and various policies aimed at protecting its
interests. The consolidation and concentration of economic power in the
government's hands has given rise to the catch-phrase ``The state
advances, the private [sector] retreats.'' For a detailed discussion of
the Chinese government's role in and control over the Chinese economy,
see U.S.-China Economic and Security Review Commission, 2012 Report to
Congress (Washington, DC: U.S. Government Printing Office, November
2012), pp. 47-72.
---------------------------------------------------------------------------
The uncertainty over the prospects for economic reform is
the result of contradictory statements and actions by the new
leadership. On the one hand, there are signs that President Xi
and Premier Li are preparing a package of reforms that will be
unveiled at the Third Plenary Session of the 18th Central
Committee scheduled for November 2013. On the other hand,
President Xi has been reaffirming the role of the state in the
economy and introducing Maoist-style ideological campaigns
aimed at stamping out political liberalization. A Chinese
Communist Party (CCP) leadership statement approved by
President Xi, ``Document No. 9,'' enumerates seven perils for
China, among them, ``Western constitutional democracy,'' human
rights, media independence, and market-based ``neo-
liberalism.'' \6\ The fundamental conflict is that the economic
liberalization the leadership expounds is impossible to achieve
if the government continues to expand its ownership of and
control over the economy.
Before handing over the reins, President Hu delivered a
joint report at the beginning of the 18th Party Congress.
Speeches delivered to the Party Congress are considered guides
to future policy, especially during a power transition, because
they are drafted by both incoming and outgoing leaders. The
outgoing president's speech was interpreted by many analysts as
a blow to economic reform. For example, the report contained
strong language on the need to strengthen the state-owned
portion of the economy. The departing President Hu said China
would ``unwaveringly consolidate and develop public ownership''
and ``steadily enhance the vitality of the state-owned sector
of the economy and its capacity to leverage and influence the
economy.'' \7\ The report proclaimed that state-owned
enterprises (SOEs) are the principal part of the Chinese
economy and that they will increase their investment in areas
of the economy that impact national security and core national
interests.
Six months earlier, Mr. Xi had made his first trip as
leader to the southern Chinese city of Shenzhen, in a gesture
interpreted as more reformist, because it paralleled a similar
trip by Deng Xiaoping during his famous ``southern tour'' to
the same area 20 years ago.* President Xi followed up with
trips to the countryside to highlight the plight of the rural
poor.
---------------------------------------------------------------------------
* During his 1992 southern tour, Deng Xiaoping stressed the
importance of continuing economic reforms launched in 1978 and
criticized those who were against further economic and openness
reforms.
---------------------------------------------------------------------------
Premier Li, who is broadly responsible for formulating and
implementing economic and domestic policy, gave an early speech
at a meeting of representatives of the 11 national
``Comprehensive Reform Pilot Areas,'' which was interpreted by
some western analysts as signaling his commitment to economic
reform.\8\ In particular, the speech started off noting that
``reform is like a boat beating against the current; if you
don't move forward, you will slip backwards.'' At the March
2013 annual Party Congress, Premier Li gave his first news
conference. He pointed to the need to ``shake up vested
interests,'' stating that ``however deep the water may be, we
will wade into the water.'' \9\ The government would have to
enact a ``self-imposed revolution,'' which would be ``very
painful and even feel like cutting one's wrist.'' \10\ The
reformist tone aside, Premier Li has loyally supported former
President Hu's policies, which have hindered or reversed
economic reform.
------------------------------------------------------------------------
------------------------------------------------------------------------
The New Economic Leadership Team
The National People's Congress meeting in March 2013 revealed the
makeup of the economic leadership team that will be in charge of
crafting economic policy for China's new administration. The lineup
appears encouraging for economic reform; however, these individuals,
though involved in policy-making, are not on the Standing Committee and,
therefore, do not set the direction of China's economic policy. Much
will depend on whether these individuals will be willing and able to
sway the leadership toward economic reforms. Three top decisionmakers
are highlighted below.
------------------------------------------------------------------------
------------------------------------------------------------------------
------------------------------------------------------------------------
The New Economic Leadership Team--Continued
Zhou Xiaochuan was asked to stay on as head of the People's Bank of
China (PBOC), the central bank. Observers were surprised by the
announcement that Mr. Zhou will remain in his position since he turned
65 in January 2013, the ordinary retirement age for a minister-level
official. According to insiders, the move is aimed at ensuring
continuity in financial-sector policy-making and signals a desire to
stay on course with the kind of financial reforms Mr. Zhou has
championed, including a more flexible renminbi (RMB) exchange rate and
market-based interest rate system.\11\
Lou Jiwei was appointed minister of finance. Mr. Lou, best known
abroad as the former head of China's most public sovereign wealth fund,
the China Investment Corporation (CIC), was a deputy finance minister
for ten years and is known for his support of financial
liberalization.\12\ His comments at the 2013 Strategic and Economic
Dialogue (S&ED) talks in Washington generated some controversy when
Xinhua, the official CCP propaganda arm and news agency, censored his
remarks regarding China's target GDP growth in 2013. Mr. Lou said,
``There is no doubt that China can achieve the growth target, though the
7 percent goal should not be considered as the bottom line,'' but Xinhua
changed that to ``7.5 percent'' (the official target) in its
reporting.\13\
Liu He, long recognized as the key economic adviser to Xi Jinping, was
confirmed as the official head of the Leading Group for Financial and
Economic Affairs of the CCP Central Committee.\14\ Mr. Liu will also
hold an appointment as a vice head of the National Development and
Reform Commission (NDRC), China's chief economic planning body. As the
head of the Leading Group for Financial and Economic Affairs, Mr. Liu
will lead the writing of the official documents framing economic reforms
planned over the next five years.\15\ According to Cheng Li, a China
scholar at The Brookings Institution, Mr. Liu was a ``major
collaborator'' in last year's World Bank report \16\ that advocated
accelerating market-driven change and is a proponent of financial
liberalization.\17\
------------------------------------------------------------------------
Economic policymakers have identified and registered some
limited successes in addressing problems that threaten to
foment unrest among Chinese citizens who are not part of the
urban coastal elite. In recent months, the government has
introduced some important initiatives aimed at addressing some
of the country's growing inequalities of wealth and
opportunity.
Inequality: Even as President Xi and Premier Li's rhetoric
indicates a reformist bent, resistance to reform from
entrenched local interests and the export sector remains
strong.\18\ Although the Chinese government has been successful
in lifting millions out of poverty, China's level of inequality
has been steadily rising. In February 2013, the State Council
released a new plan aimed at curbing inequality and redressing
some of the worst gaps in development between urban and rural
populations.* The plan includes an ambitious agenda for
expanding the social safety net, improving healthcare and
education, limiting the power of SOEs, and tackling corruption
by government officials.
---------------------------------------------------------------------------
* For an in-depth analysis of the new reform plan, see Nargiza
Salidjanova, China's New Income Inequality Reform Plan and Implications
for Rebalancing (Washington, DC: U.S.-China Economic and Security
Review Commission, March 12, 2013). http://origin.www.uscc.gov/sites/
default/files/Research/China-%20-Inequality-%20-
%20-3-%20-12-%20-13-.-pdf.
---------------------------------------------------------------------------
The 35-point ``Income Distribution Plan'' is aimed at
boosting minimum wages to at least 40 percent of average
salaries, loosening controls on bank lending and deposit rates,
and increasing spending on education and affordable
housing.\19\ Other reforms include a requirement that SOEs
contribute more of their profits to the effort of reducing
inequality and a commitment to push through market-oriented
interest rate reforms to give savers a better return and more
security. In theory, these measures signal an attempt to shift
the economy toward increased domestic consumption as an
underpinning for economic growth. As with most sweeping Chinese
government plans, everything depends on implementation. For
example, past proposals to encourage higher dividend payments
from SOEs collapsed under fierce resistance from the
politically powerful heads of the SOEs, who are also ranking
Communist Party members. Similarly, corruption is endemic among
local government officials, and addressing its manifestations,
such as land seizures from peasant farmers, might undermine the
stability of the CCP (see below).
Corruption: A Pew Research Center poll last year showed a
rise between 2008 and 2012 in Chinese public concern about
corrupt officials. The anticorruption group Transparency
International last year ranked China number 80 out of 174
countries in terms of perceptions of corruption in the public
sector, worse than Liberia, Italy, and South Africa.
Transparency International excluded China from its 2013 survey
on corruption because local polling survey firms, which are
licensed by the government, said they would have to omit
certain questions in order to be allowed to conduct the
survey.\20\
Upon becoming president last November, Mr. Xi vowed to
eliminate the ``tigers and flies'' (i.e., high-ranking as well
as low-ranking officials) who had enriched themselves through
bribery and patronage. He denounced the prevalence of
corruption and said officials needed to guard against its
spread, or it would ``doom the Party and the state.'' \21\ Some
observers took Wang Qishan's assignment as the director of the
CCP's watchdog agency for corruption, the Central Disciplinary
Inspection Commission, as a sign of the government's
seriousness about the issue. Mr. Wang's previous experience in
banking and international trade might have made him a better
fit in an economic position, but reformers applauded Mr. Wang's
choice because he has a strong reputation as a ``firefighter''
and capable problem solver.\22\
In the past, the Chinese government has paid lip service to
tackling corruption without undertaking any actual reform. The
current anticorruption campaign appears similarly aimed at
placating the public anger or eliminating political enemies
rather than creating genuine change. For example, the focus on
Chinese officials and executives at China's big, state-run
companies appears to be politically motivated.\23\ The head of
the State-owned Assets Supervision and Administration
Commission, the agency responsible for supervising state-owned
assets, was recently removed for ``serious disciplinary
violations.'' He is a close associate of Zhou Yongkang, former
domestic security chief, who is also targeted in the current
campaign.\24\ Four senior managers at PetroChina have been
removed amid separate investigations by authorities; one of the
executives is a former aide to Mr. Zhou.\25\
President Xi has spearheaded an austerity drive, banning
banquets, gift-giving, and other lavish trappings of Chinese
officialdom. There are signs that this is having a real impact:
First-class airline ticket sales have dropped by a tenth in
recent months; luxury goods dealers have reported a 20 percent
to 30 percent decrease in sales; and restaurants surveyed in
February experienced a 60 percent drop in reservations over the
same period in 2012.\26\
The Chinese government also issued a directive banning the
construction of government buildings for the next five years.
The new directive is a continuation of the anticorruption
campaign, describing the ban as ``important for building a
clean government'' and improving the ties between the party and
the people.\27\ Grandiose official galas, which often feature
variety shows and celebrity appearances, are likewise banned,
because they are ``wasteful'' and had ``damaged the image of
the Chinese Communist Party and the government, triggering
public complaints.'' \28\
The affected local governments are finding ways to side-
step these bans. According to a report in Xinhua, local
government officials in some provinces are reclassifying
government buildings in order to avoid notice. For example, in
Jiangsu Province, the government power company offices have
been renamed ``dispatch centers,'' and public security offices
have been renamed ``technical investigation centers.'' \29\
Furthermore, the construction ban does not address the
proliferation of so-called ``luxurious canteens,'' or deluxe
cafeterias in government offices.
While the anticorruption efforts have appeared in the
headlines, the reality presents a more confusing picture. For
example, a proposed regulation that would require top officials
to publicly disclose their personal assets has stalled.\30\
Moreover, just as the prohibition on new government buildings
was being announced, the government started to round up and
prosecute activists who called on officials to disclose their
wealth and the wealth of their families. In the most celebrated
case, Xu Zhiyong, a prominent human rights activist, was
charged with ``assembling a crowd to disrupt order in a public
place.'' \31\
Despite official proclamations, so far the CCP has
demonstrated ``little inclination'' to pursue any fundamental
reforms to root out corruption, according to Elizabeth Economy,
director for Asia Studies at the Council on Foreign Relations.
Instead, the latest measures will most likely follow an
established pattern: ``a number of high-profile arrests, no
institutional change [. . .], and an endless cycle of
anticorruption campaigns.'' \32\ According to Minxin Pei,
professor of political science at Claremont McKenna University,
President Xi does not actually want to end corruption, because
it is the lifeblood of the Chinese government: ``The Communist
Party is a patronage machine and patronage by definition is
corruption.'' \33\ In other words, while fighting corruption
might endanger the party, cracking down on the appearance of
corruption is a good measure to address the ``public relations
nightmare that accompanies corruption.'' \34\ Party officials
remain staunchly opposed to disclosing their assets, and both
The New York Times and Bloomberg websites were blocked in China
after reporting on the wealth amassed by the families of former
Premier Wen Jiabao and Xi Jinping, respectively.
Urbanization: Premier Li has made urbanization the core of
his agenda, calling it ``the biggest development potential.''
\35\ Government departments are drawing up policies to guide
rural citizens into cities over the next decade.\36\ The hope
is that urbanization will become the next growth engine,
initiating a new wave of investment, adding to the consumer
class, and creating a surge in demand for housing and
infrastructure.\37\ The urbanization drive may also boost
Chinese efforts to make more land available for agriculture and
improve farming efficiency (for more on the government's
agriculture modernization efforts, see chap. 1, sec. 4, of this
Report).
The effect is likely exaggerated. For example, in many
cases urbanization will simply entail the reclassification of
rural areas as urban and not boost consumption or
investment.\38\ In addition, unscrupulous officials might use
the excuse of urbanization to seize village land, which they
then may sell to developers without compensating the farmers.
The key test of the Chinese government's ability to push
through greater urbanization will be how it plans to pay for
it. The Chinese Academy of Social Sciences, a government think
tank, estimates the cost (including spending on healthcare,
housing, and schools) at $106 billion a year, the equivalent of
5.5 percent of fiscal revenue in 2012.\39\ Local governments
cannot pick up the check for the expansion of such costly
spending since they do not have a steady tax revenue stream: By
law they must give most tax receipts to the central government.
As a result, most local governments rely on land seizures and
sales to fund spending, already a large contributor to public
perceptions of corruption since farmers receive comparatively
little from the government,
No urbanization initiative can be fully successful without
first tackling one of the key factors behind the rural-urban
disparity: China's system of household registration, known as
hukou.* People from the countryside with a rural registration,
or hukou, are restricted from enjoying the far better education
and health benefits available to those with an urban hukou.
Allowing migrants to the cities to obtain an urban hukou has
been met with strong resistance from local governments that
fear being overwhelmed by a flood of new migrants.\40\ There
are small signs of change. A report issued by the State Council
suggests that the government is considering relaxing hukou in
small cities ``in an orderly manner'' in tandem with the
urbanization drive, to be followed by bigger cities.\41\
---------------------------------------------------------------------------
* Created in its current form in 1960, China's modern hukou was
first developed after 20 million migrants rushed to China's urban
cities during the Great Leap Forward (1958-1960) in order to fill a
perceived labor gap. The hukou system requires the registration of all
citizens in China at birth and then limits access to government
services based on the residency permits issued after registration.
Citizens' residency permits fall into one of two categories, urban or
rural hukou, and entitle a holder access to social services in the town
or city to which their hukou is registered. For more on the hukou
registration and its impact on migrant workers, see ``China's Internal
Dilemmas'' in U.S.-China Economic and Security Review Commission, 2011
Report to Congress (Washington, DC: U.S. Government Printing Office,
November 2011), pp. 107-128. www.uscc.gov/Annual--Reports.
------------------------------------------------------------------------
------------------------------------------------------------------------
The Mini Stimulus
In July 2013, the Chinese government announced a package of measures
aimed at boosting the slowing economy while at the same time staying
away from the massive investment drive. It also appears aimed primarily
at small- and medium-sized private enterprises rather than SOEs, which
were the main beneficiaries of the 2008 stimulus package. A statement by
the State Council described a three-pronged approach: a temporary tax
cut (scrapping all value-added and operating taxes) for more than six
million small- and medium-sized enterprises; reduction of approval
procedures and administrative costs for exporting companies; and more
investment in railway construction in China's central and western
regions.\42\
In recent decades, the CCP has derived its legitimacy from growth, so
the government's willingness to tolerate slow growth may be finite,
particularly if unemployment rates rise. A major test for China will be
how the rest of the global economy performs. Many analysts believe the
top priority for the new leadership is not reform but making sure that
growth does not deviate far from the official 7.5 percent target. If the
economies of China's biggest trading partners, the United States, the
European Union (EU), and Japan, remain weak, the pressure on the Chinese
economy may force the new government to return to such policies as
further credit expansion or infrastructure investment, which shore up
growth in the short term but also create more problems in the future,
such as inflation, overcapacity, excessive debt, and economic
uncertainty.
------------------------------------------------------------------------
Rebalancing China's Economy
Economic rebalancing is a multifaceted challenge for China
that not only entails lowering investment and increasing
overall consumption but also scaling down the role of the state
sector, reducing speculative investment in real estate,
altering the way credit is allocated, and speeding growth of
the services sector. Some economists predict that effective
rebalancing of China's economy will result in more sustainable
long-term growth.\43\ Failure to make necessary reforms to
rebalance China's economy may result in reduced output,
widespread defaults, stress on the banking sector, and social
unrest.\44\ But in the past year, China has made little
progress toward its stated goal and, in some cases, has
regressed to the old, short-term solutions: ramping up exports
through subsidies to exporters and borrowing to undertake
infrastructure projects and increase factory output.
Although China marginally reduced its massive trade surplus
in the years immediately following the 2007-2008 global
financial crisis, this progress was temporary and largely
attributed to domestic stimulus and slowing demand in western
economies. Rebalancing China's domestic economy has lagged even
more so, as some positive trends proved to be short-lived.
There are good reasons for the Chinese government not to
try to boost growth with additional stimulus or policies to
expand exports: A GDP slowdown may help Beijing tackle some of
the structural problems with the economy, once described by
former Premier Wen Jiabao as ``unbalanced, uncoordinated, and
unsustainable.'' Patrick Chovanec, an economist who has written
extensively about the Chinese economy, says that ``if China
slowed for the right reasons, by being more selective with
their investments, and moving toward more consumption, a slight
slowdown would actually be a good thing.'' \45\ Proper economic
rebalancing, however, cannot happen without a significant
decrease in medium-term growth rates, and the government's
willingness to tolerate slow growth on a sustained basis is
untested.
External Rebalancing
Balancing China's external accounts with other nations--or
reducing China's massive trade surplus by increasing the import
share of total trade--is a key element in rebalancing China's
economy. Following the global financial crisis, China made
progress in reducing its global trade surplus, which fell as a
share of GDP from a peak of 10 percent in 2007 to 2.7 percent
in the first half of 2013.\46\ However, the decline in China's
trade surplus with the world is not necessarily an outcome of
deliberate structural rebalancing. In the first half of 2013,
China's goods exports outpaced goods imports by 4 percentage
points, causing its trade surplus with the world to grow by 40
percent year-on-year to $157 billion.\47\ The International
Monetary Fund (IMF) projects that China's current account
surplus will rise from 2.7 percent to 4 percent of GDP by 2018.
This forecast assumes that there will be a gradual recovery in
global demand, minimal appreciation of the RMB, and limited
progress in domestic rebalancing.\48\
The United States is among the countries most affected by
China's export surplus (see figure 3). The U.S. cumulative
bilateral deficit with China has risen to more than $3 trillion
since 1979.\49\ For the first six months of 2013, China's goods
trade surplus with the United States was $148 billion; a decade
ago, that figure stood at $54 billion. While China sold 17
percent of its total goods exports to the United States in
2012, it purchased just 7 percent of total U.S. exports.\50\
More strikingly, China in 2012 was responsible for nearly
three-quarters of the U.S. trade deficit in non-oil
products.\51\
Figure 3: U.S.-China Trade Deficit in Goods, 2000-2012
(US$ billions)
Source: U.S. Bureau of Economic Analysis.
To be sure, U.S. manufactures exports to the world improved
slightly in the first half of 2013, registering a lower deficit
than in the prior year. Some industry experts have interpreted
this as a sign of rising competitiveness in U.S. industry,
driven in part by low energy prices.\52\ Nevertheless, the only
manufacturing sector in which the United States registered a
substantial trade surplus with China was transportation
equipment ($3.6 billion), which comprises automotive, aircraft,
and ship products. Other sectors with a substantial surplus
were agriculture ($6.3 billion), waste and scrap ($4.2
billion), and minerals and ores ($1.3 billion). The United
States has a persistent trade deficit with China in advanced
technology products. Although exports to China have improved in
the first half of 2013, the total value of trade in those
sectors is small (see table 1).
Table 1: U.S. Trade Balance with China in Advanced Technology Products, January-June, 2012-2013
(U.S. millions)
----------------------------------------------------------------------------------------------------------------
YTD YTD
Exports Imports Balance Balance Change
Jun'13 Jun'12 2012-2013
----------------------------------------------------------------------------------------------------------------
TOTAL............................................... 7,828 42,327 -34,499 -35,418 919
(01) Biotechnology...................................... 122 25 97 58 39
(02) Life Science....................................... 901 667 234 156 78
(03) Optoelectronics.................................... 102 1,335 -1,233 -2,429 1,196
(04) Information & Communications....................... 1,375 38,607 -37,232 -35,717 (1,515)
(05) Electronics........................................ 1,439 1,049 390 163 227
(06) Flexible Manufacturing............................. 713 278 435 185 250
(07) Advanced Materials................................. 77 70 7 15 (8)
(08) Aerospace.......................................... 2,901 256 2,645 2,162 483
(09) Weapons............................................ 1 39 -38 -34 (4)
(10) Nuclear Technology................................. 199 1 198 23 175
----------------------------------------------------------------------------------------------------------------
Source: U.S. Census Bureau, NAICS database (Washington, DC: U.S. Department of Commerce, Foreign Trade
Division). http://censtats.census.gov/cgi-bin/naic3--6/naicCty.pl.
There are four important preconditions for increasing
China's imports as a share of total trade. First, China must
further open its market to imports in order to allow increased
competition to stimulate consumption. At the China Development
Forum held in March, Premier Li acknowledged as much, promising
that ``China will expand its opening-up policy, and the nation
needs to promote domestic consumption through continuing to
open up its markets.'' \53\ Second, the RMB must continue to
appreciate against the dollar, to lower the price of U.S. goods
and services in China. Third, household disposable income must
continue to grow to create sufficient domestic demand. Fourth,
China must reduce its household and corporate savings rate.
Money that is not saved or invested is necessarily spent, often
on imports. In 2012, however, China's private savings rate
reached the world's highest level, surpassing 50 percent, well
above the global average of 20 percent. The high savings rate
is largely attributed to China's low level of government safety
net spending on health, education, and old age pensions, high
down payment requirements for securing mortgages, negative or
low real interest rates on ordinary bank deposits, and capital
controls that restrict Chinese citizens from investing
abroad.\54\
RMB Revaluation
The RMB has continued to slowly appreciate against the
dollar, gaining less than 2 percent in the first half of
2013.\55\ This represents a slowdown in appreciation from
previous years, particularly when compared to the period 2005-
2008 (see figure 4). The rise of the RMB is still not
controlled by market forces; the PBOC resets the value of the
currency at the start of each trading day, allowing only 1
percent daily fluctuation. In January, strong market pressures
to appreciate the currency were offset by interventions in the
international currency market by the central bank and China's
state-owned commercial banks, which purchased a record $110
billion worth of foreign exchange within a matter of days.\56\
Figure 4: Appreciation of the RMB, 2004-2013H1
Note: ``2013H1'' includes data from January to June 2013.
Source: China State Administration of Foreign Exchange, via CEIC
database.
The Commission in past years has characterized the value of
the RMB as ``manipulated'' by the Chinese central bank in an
effort by the government to discount its exports to the United
States and raise the price of U.S. exports to China. The
intended purpose is to create and maintain an artificially high
surplus in China's bilateral trade with the United States. The
U.S. Treasury Department chooses not to use this technical term
in order to avoid mandatory countermeasures dictated by U.S.
law * but acknowledges that China's exchange rate ``continues
to be tightly managed'' and ``continues to exhibit significant
undervaluation.'' \57\
---------------------------------------------------------------------------
* The U.S. Treasury Department is required by the Trade Act of 1988
to report to Congress twice yearly on the exchange rate policies of
major trading partners and to identify countries that ``manipulate the
rate of exchange between their currency and the United States dollar
for purposes of preventing effective balance of payments adjustment or
gaining unfair competitive advantage in international trade.'' The
Administration would be required to open negotiations with any country
so designated.
---------------------------------------------------------------------------
As in previous administrations, the U.S. Treasury
Department has taken up the issue with China during bilateral
talks and received assurances from top Chinese officials that
change will be forthcoming and that market forces will be
allowed a ``bigger role'' in determining the value of the RMB.
However, China still refuses to publish data on exchange rate
interventions by the central bank, in contrast to other G-20
members. Such interventions, combined with China's subsidies to
exporting industries, have helped China accumulate the world's
largest foreign currency reserves--$3.66 trillion by the end of
September 2013--almost as large as the total amount of foreign
exchange reserves held by all advanced economies combined.\58\
The monthly U.S. trade deficit in goods with China hit a record
$30.1 billion in July.\59\
------------------------------------------------------------------------
------------------------------------------------------------------------
Further Developments in RMB Internationalization
As part of a push to internationalize the RMB, China has been
developing an offshore market for it as a precursor to allowing global
firms, banks, and asset managers access to its domestic market. China
has currency swap lines * with around 20 countries, mostly small,
emerging economies that have natural resources, such as Argentina and
Indonesia, but no major economic powers like the United States or EU
countries. That may be about to change as China established two
important swap agreements with major trade partners. First, the Bank of
England, Britain's central bank, and the PBOC established a currency
swap line in June 2013. The agreement will initially last for three
years and has a maximum value of 200 billion RMB ($32.6 billion).\60\
Then, in October 2013, China agreed to swap euros and RMB with the
European Central Bank, China's second largest swap deal. The swap
agreement has a maximum size of RMB 350 billion ($60.8 billion) and is
valid for three years.\61\
In January 2013, Taiwan and China formally established a direct RMB-
clearing system between them, following a signing of a cross-Strait
currency clearing last year. Taiwan will become the third place with
such a clearing arrangement with China, after Hong Kong and Macau. Under
the agreement, Taiwan's and China's central banks will be able to settle
directly in RMB payments without first converting their currencies into
U.S. dollars, which is the current practice.\62\
On April 25, 2013, the government in Hong Kong loosened restrictions
on interbank trading of the RMB, a move that is intended to enhance Hong
Kong's status as an offshore RMB trading center, a segment that is
witnessing competition from other financial centers.\63\ Global use of
the RMB for trade settlement is limited but has been rising steadily. By
June 2013, the volume of RMB used to settle trade was 174 percent higher
than in January 2012, when the policy was first introduced.\64\ The
Chinese currency now ranks 13th in the world for cross-border payments,
up from 20th this time last year, according to SWIFT, the global
payments company.\65\ True RMB internationalization stays out of reach,
however, as long as China's capital account remains closed, which makes
use of RMB for trade settlement and investment difficult.
------------------------------------------------------------------------
Domestic Rebalancing
As of 2013, imbalances in China's domestic economy remain
substantial. Beijing's economic policy has resulted in what the
IMF calls a ``pattern of growth [that] has become too reliant
on investment and an unsustainable surge in credit, resulting
in rising domestic vulnerabilities.'' \66\ Rebalancing toward
consumption-driven growth can only be achieved if consumption
continually grows faster than investment for many years. Yet
while private and government consumption accounted for more
than half of China's GDP growth in 2011-12, the trend reversed
in the first half of 2013.\67\ Nicholas Borst of the Peterson
Institute for International Economics rated China's progress in
rebalancing a grade of ``D'' and ``F'' for the first and second
quarters of 2013, respectively.\68\ His perspective summed up
the consensus that China has experienced no significant
domestic rebalancing this year.
---------------------------------------------------------------------------
* Under a swap agreement, central banks agree to exchange each
other's currency and can then lend the money to domestic banks to
improve liquidity.
---------------------------------------------------------------------------
In the first half of 2013, consumption's contribution to
economic growth fell below investment for the first time since
2010. Consumption contributed 45.2 percent to GDP growth, down
15.4 percentage points from the first half of 2012. Investment,
however, increased to 53.9 percent, up 2.7 percent from 2012
(see figure 5).\69\ In China, consumption's share of GDP
remains low compared to other countries. Globally, it
represents about 65 percent of GDP, and China's share of
consumption is still far lower than developed western
economies, where consumption accounts for over 70 percent of
GDP (see figure 6).\70\
Figure 5: China's Consumption vs. Investment, 2009-2013
(as share of GDP growth; in percent)
Source: China National Bureau of Statistics, via CEIC database.
The IMF has warned that if credit-fuelled investment in the
manufacturing sector remains high, resources are likely to be
wasted and nonperforming assets will accumulate, because such
investment will only add to China's industrial
overcapacity.\71\ Numerous examples of overinvestment and
excess supply resulting in overcapacity have already arisen in
the steel, shipbuilding, and solar manufacturing industries,
which has resulted in insolvency and employee layoffs for many
companies.\72\ This slowdown in the manufacturing sector has
resulted in diminishing returns on the government's investment.
Beijing has expressed tolerance for slower economic growth
while it claims to be directing China's economy toward more
domestic consumption.\73\ Despite this, independent analysts
believe that China's new leaders lack the political will to
adopt an ambitious rebalancing agenda.\74\
Figure 6: Composition of China's GDP, 2000-2012
Note: 2012 data for ``imports of goods and services'' and ``exports
of goods and services'' were not yet released by the World Bank at the
time of publication.
Source: World Bank China data (Washington, DC: 2013). http://
data.worldbank.org/country/china.
The most important--and most challenging--element of
domestic rebalancing is increasing household consumption as a
share of GDP.* Households' consumption has declined as a share
of China's GDP for decades while the share of fixed-asset
investment has grown. Although year-on-year growth of urban
household consumption has been expanding at a steady rate of
9.7 percent for the past ten years, in the first half of 2013,
growth in urban household consumption dropped to 7.2
percent.\75\ Meanwhile, fixed-asset investment grew by 20
percent.\76\ Although for the past decade real annual growth of
household consumption in China has outperformed a dozen major
economies, including Brazil and India, as long as
fixed-asset investment is growing faster than household
consumption, it will be difficult to rebalance China's domestic
economy.
---------------------------------------------------------------------------
* Household consumption is generally defined as expenditures for
goods and services by a household, excluding the purchase of a home but
adjusting for ``imputed rent'' or the amount that a household would pay
to rent the same residence. It includes healthcare and education--even
that portion supplied by the government--but does not include taxes
paid to government nor does it include savings or investments by the
household.
According to Daniel H. Rosen and Beibei Bao of the Rhodium
Group, it is unreasonable to expect household consumption to grow
faster than its current rate. They argue that effective rebalancing
will not depend on a growth in household consumption but on reduced and
better managed investment growth. Daniel H. Rosen and Beibei Bao,
``China Has Problems, But Household Consumption Isn't One,'' Caixin,
September 20, 2013. http://english.caixin.com/2013-09-20/
100584374.html.
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An important factor in increasing household consumption's
share of GDP is sustained growth in disposable income minus any
increase in the household savings rate.\77\ If disposable
income grows and the household savings rate remains stable or
declines, this will result in more spending by Chinese
consumers--a positive sign for domestic rebalancing. In the
first half of 2013, however, the opposite occurred. Growth in
nominal median urban household income took a dive, declining by
5.8 percentage points. The urban household savings rate
remained high, reaching 35.6 percent, up 1.1 percent from 2012.
And, most notably, there was lower growth of real urban
disposable income.\78\ These three factors--slowing income
growth, an increasing household savings rate, and a drop in
growth of urban disposable income--cut into overall household
consumption. In turn, the slowdown in household consumption
contributed to an overall slowdown in retail sales. Year-on-
year growth in retail sales for the first half of 2013 was down
to 12.7 percent from 14.4 percent in 2012.\79\ On a quarterly
basis, growth in retail sales was down an average 1.3 percent
from last year.*
---------------------------------------------------------------------------
* Data used in calculation exclude the months of January and
February. China National Bureau of Statistics, via CEIC database.
---------------------------------------------------------------------------
Financial reform is also integral to rebalancing China's
economy. Continued reform in China's banking system is a
precondition to increasing access to credit and providing
higher returns on household deposits. The new leadership made
progress toward financial reform in July 2013 when the PBOC
announced it would eliminate the floor on lending rates,
allowing banks more freedom to compete by offering cheaper
loans.\80\ As a result, loans may become more accessible to
small- and medium-sized enterprises. Although removing the
floor on lending rates is a major step in financial reform, the
PBOC did not remove the more important ceiling on deposit
rates. The ceiling limits the rate that banks can pay
depositors and ultimately stymies growth in household
disposable income.\81\ The PBOC acknowledged that removing
curbs on deposit rates would have a greater effect on
consumption than lending rate reform.\82\
Maintaining positive real interest rates would also play a
role in increasing the returns for China's households. Interest
rates on one-year deposits lagged behind inflation and were
thus negative from 2010 to 2011, which adversely affected
household consumption by cutting into disposable income.
Depositors find that their savings have less purchasing power
over time when inflation exceeds their return on savings.
Although real interest rates have been positive since peaking
at 1.5 percent in June 2012, they dropped to 0.3 percent in
2013.\83\ As a result of the low interest rates, many seeking
higher returns will favor alternatives in China's property
sector, a cycle that will only result in increased fixed-asset
investment and further inflation of China's real estate bubble.
China implemented a new set of controls in March 2013 on
the housing market that were targeted at curbing speculative
investment in real estate.\84\ However, growth of investment in
residential real estate continues to exceed real GDP growth,
and reports of excess housing stock have indicated that it is
unlikely that real estate investment is driven by actual
demand.\85\
Monetary Policy
Management of Foreign Exchange Reserves
The reserve assets held by China's central bank grew by
$169 billion in the first half of 2013--$37 billion more than
in all of 2012. Although China's reserve accumulation
has slowed significantly since 2011, cumulative reserves are
still extremely large, exceeding the combined foreign holdings
of Japan, Norway, the United Arab Emirates, and Saudi Arabia,
which rank directly behind China as the top foreign exchange
reserve holders (see figure 7).\86\
---------------------------------------------------------------------------
Total ``reserve assets'' are primarily comprised of
foreign exchange. By the end of September 2013, China's foreign
exchange reserves reached $3.66 trillion.
---------------------------------------------------------------------------
China's share of U.S. Treasuries in foreign hands increased
to 23.2 percent in 2013, cementing its rank as the world's
largest holder of U.S. Treasury securities. Other top holders
of U.S. Treasuries, such as Japan, Brazil, and Taiwan, all saw
their shares decrease over this period.\87\ As of June 2012
(most recent data), China was also the second-largest holder of
U.S. agency debt, at $202 billion.
Figure 7: Growth of China's Reserve Assets, 2003-2013
Cumulative (US$ trillions); Annual (US$ billions)
Note: ``2013H1'' refers to first half of 2013. Numbers for 2003 to
2010 are from China State Administration of Foreign Exchange's balance
of payments data. Numbers for 2011 to 2013 are from the State
Administration of Foreign Exchange's quarterly report on the
international investment position, which are more widely used by
economists but are not available for the period before 2011.
Source: China State Administration of Foreign Exchange, via CEIC
database.
While maintaining a preference for government securities,
China continues to diversify its foreign exchange assets.
China's nonfinancial outbound foreign direct investment (FDI)
for the first half of 2013 totaled $45.6 billion, up 29 percent
from the prior year.\88\ One motive behind China's outbound FDI
is to acquire resources and enter new markets overseas. In this
context, China is increasing its direct ownership of foreign
companies. Another motive, which also relates to China's
portfolio investments and overseas loans, is to counteract the
depreciation of the dollar against the RMB and to earn a higher
yield than is provided by U.S. Treasuries.\89\ (For an analysis
of China's foreign investment in the United States, see chap.
1, sec. 2, of this Report.)
------------------------------------------------------------------------
------------------------------------------------------------------------
Rising Competition among China's Sovereign Wealth Funds
China Investment Corp. (CIC),* established in 2007, is the only state-
sponsored investment vehicle recognized by the Chinese government as a
sovereign wealth fund. But, according to the Sovereign Wealth Fund
Institute, an international research body, mainland China currently has
three other entities that may qualify as sovereign wealth funds--State
Administration of Foreign Exchange (SAFE) Investment Company,
the National Social Security Fund, and the China-Africa Development
Fund.Sec. Each investment fund serves separate interests among branches
of the Chinese government and competes with other state-sponsored
entities for access to China's foreign exchange reserves.
The Ministry of Finance has been the strongest supporter of CIC and
has advocated that the fund act as China's primary outbound
investor.\90\ Lou Jiwei, formerly the vice minister of Finance, served
as CIC's chairman in 2007-2013.\91\ As part of the leadership
transition, he was appointed as minister of finance in March 2013.\92\
After some bureaucratic infighting, Mr. Lou was replaced at CIC by
another Ministry of Finance official, effectively allowing the ministry
to retain its influence over the fund.\93\ China's central bank, on the
other hand, has preferred to invest the country's dollar reserves
through other state-sponsored investors. SAFE, the subsidiary of the
central bank that manages the bank's foreign exchange, is subject to
less external pressure than CIC, because it does not participate in
internationally recommended practices on transparency.para.
------------------------------------------------------------------------
---------------------------------------------------------------------------
* CIC is registered as a state-owned enterprise under China's
Company Law. Unlike SAFE Investment Company and the National Social
Security Fund, it is not a legal subsidiary of any government agency.
It reports like a ministry directly to the State Council, China's
highest administrative body. Under CIC's Articles of Association, five
government agencies--the People's Bank of China, SAFE, the Ministry of
Finance, the Ministry of Commerce, and the National Development and
Reform Commission--have a seat on the fund's board.
SAFE Investment Company is a limited company that was
registered in Hong Kong prior to the handover of the island to mainland
China. It constitutes one of four overseas investment arms of the State
Administration of Foreign Exchange. The State Administration of Foreign
Exchange is the branch of the People's Bank of China, China's central
bank, which exclusively manages China's foreign exchange reserves. SAFE
Investment Company's primary objective is to retain the value of
China's foreign exchange by making portfolio investments overseas.
= Established by the State Council, under the auspices of the
Ministry of Social Security, the National Social Security Fund is a
public pension fund under China's Social Insurance Law. Its objective
is to maintain the real value of public pension proceeds as a means to
support future social security expenditures. The National Social
Security Fund can invest 20 percent of its funds outside China.
Sec. The China-Africa Development Fund is a small fund set up to
foster economic ties between China and Africa. It functions as a branch
of China Development Bank, China's largest policy bank, though various
government ministries are represented on its board. It is worth noting
that the China Development Bank is majority owned by Central Huijin,
the domestic subsidiary of CIC.
para. CIC is a participant in the International Forum of Sovereign
Wealth Funds (IFSWF) and has endorsed the Generally Accepted Principles
and Practices, or ``Santiago Principles,'' a set of recommended
practices for sovereign wealth funds that calls for increased
transparency. SAFE, however, does not participate in the IFSWF.
------------------------------------------------------------------------
------------------------------------------------------------------------
Rising Competition among China's Sovereign Wealth Funds--Continued
China's sovereign wealth funds rank among the world's largest in terms
of assets and have developed substantial portfolios in the United
States. CIC has acquired stakes in and loaned capital to major U.S.
companies in energy and financial services.\94\ CIC's subsidiary, the
bank holding company Central Huijin, also owns shares in China's largest
commercial banks, which have opened branches in the United States.\95\
SAFE has become a more aggressive investor and has moved beyond U.S.
Treasuries to riskier asset classes.\96\ In 2013, SAFE opened a new
branch in New York that will invest in U.S. private equity and real
estate.\97\ In addition, China's sovereign wealth funds are contracting
U.S. fund managers, such as Blackrock and TPG, to manage large portions
of their portfolios.\98\
------------------------------------------------------------------------
Foreign exchange is being channeled into overseas lending
as well. Among the top lenders is China Development Bank,
China's largest policy bank. The bank was established in 1994
to subsidize development projects in China's most backward
regions but has vastly expanded its dollar-denominated loan
portfolio in recent years. In May, it signed a $1 billion oil-
for-loan deal with India's largest oil company, Essar Oil Ltd.
China Development Bank has issued several such loans to energy-
rich countries since 2007, notably Venezuela, Russia, and
Brazil.\99\
Currency Inflows and the Cash Crunch
China's foreign currency inflows in the first half of 2013
were large but volatile: reserve accumulation surged in the
first quarter, followed by outflows in the second quarter.\100\
Volatility in China's external accounts carried over into the
domestic financial sector, which encountered a temporary
liquidity crisis. The central bank intervened to maintain
stability in a slowing economy exposed to high levels of debt.
Export earnings and inbound FDI grew at a slow pace in the
first half of 2013, making only a moderate contribution to
China's dollar inflows (see figure 8). China's foreign exchange
reserves increased by $128 billion in the first quarter, well
above the $43 billion trade surplus and $30 billion in foreign
investments.\101\ Other factors, less tied to the health of the
economy, played a significant role in attracting capital to the
Mainland. One was the reversal of capital flight. According to
a February 2013 briefing to the Commission by the U.S.
Treasury, many wealthy individuals took money out of the
country during China's once-in-a-decade leadership transition
in 2012, due in part to concerns about political and economic
instability.\102\ China's central bank records indicate that
some $79 billion of foreign exchange outflows went unaccounted
for. The outflows of capital were so large that China's foreign
exchange reserves in 2012 grew by less than the trade surplus--
a pattern not seen since China joined the World Trade
Organization (WTO). The resumption of currency inflows in early
2013 suggested that some of the flight capital reentered the
country.\103\ Due to China's tight capital controls, a
considerable portion of the inflows entered illicitly through
over-invoicing of export revenues and other means.\104\
Figure 8: Growth of China's Exports and Inbound FDI
(January--June, 2010-2013)
YTD (year-on-year, %)
Source: China General Administration of Customs, China Ministry of
Commerce, via CEIC database.
Another factor behind China's surging capital inflows was
financial speculation. International investors borrowed U.S.
dollars at low rates of interest to purchase assets denominated
in RMB, which offered a higher yield and the potential to
profit from currency appreciation. Although the RMB did not
appreciate much in 2012, the upward pressure on the currency
resumed in 2013. This investment pattern was reinforced by the
U.S. Federal Reserve's purchases of longer-maturity assets,
such as commercial bank bonds, under the stimulus program known
as ``quantitative easing.'' First implemented in November 2008,
quantitative easing substantially lowers the longer-term cost
of borrowing in dollars.\105\
As it has done persistently since 2005, the PBOC
counteracted rapid capital inflows by heavy market
intervention. The PBOC purchased dollars with RMB in order to
support the targeted RMB-dollar exchange rate. That not only
added to the PBOC's bulging foreign exchange reserves but also
increased China's money supply, raising the risk of inflation.
To reduce those risks, the PBOC took additional
``sterilization'' measures to absorb liquidity out of the
economy--essentially issuing RMB-denominated bonds in an effort
to remove the money from circulation.\106\
Nonetheless, the liquidity buildup contributed to an
expansion of lending and debt in China. The broad money supply
(M2) * grew by 16.1 percent through April, above market
forecasts of 15.5 percent.\107\ The Chinese government's
measurement of debt, or ``total social financing,'' rose at its
fastest pace since the stimulus in 2009 (see figure 9). Much of
this credit expansion was in the ``shadow banking'' sector, in
products such as trust company loans.\108\ At the same time,
worrying trends appeared in the traditional banking sector.
Foreign currency lending increased by 37 percent year-on-year
through May--versus 16 percent for RMB-denominated loans--as
banks recycled the excess dollars coming into their
accounts.\109\ Chinese banks are less restricted in terms of
the amount of deposits they need to have available when lending
in foreign currency, a loose regulation that prompts riskier
lending. Nonperforming loans at Chinese banks also grew at
their fastest quarterly rate in a decade; an indication that
credit was not well allocated (see figure 10).
---------------------------------------------------------------------------
* Broad money (M2) is a measure of liquid money supply beyond
physical currency and demand deposits (also termed narrow money, or
M1). M2 includes time-related deposits, savings deposits, and
noninstitutional money market funds.
Figure 9: Aggregate Credit Growth in China, January 2009-July 2013
Monthly (year-on-year, %)
Source: People's Bank of China, via CEIC database.
Figure 10: Growth of China's Nonperforming Loans, 2006-2013Q1
Quarterly (year-on-year, %)
Source: People's Bank of China, via CEIC database.
Faced with a sudden rise in liquidity, the PBOC in June
began to take more drastic measures, such as imposing tougher
lending conditions on banks. These policies, which came to be
known as the ``credit crunch,'' were effective in reducing
dollar inflows. A concurrent development was the U.S. Federal
Reserve's announcement in May that it might taper quantitative
easing, a major policy shift that would raise the cost of
borrowing in dollars and reduce the relative yield on RMB-
denominated assets. In response to the Federal Reserve's
announcement, international investors rushed to transfer funds
out of China and other emerging markets.
However, the credit crunch also destabilized China's
financial sector. The primary effect was to raise interest
rates in the interbank lending market to record highs--lending
among Chinese banks froze temporarily in late June. Many
indebted borrowers worried that they would be unable to
refinance their debt.\110\ The average price-to-earnings ratio
for China's major commercial banks fell sharply on the
country's major stock exchanges, part of a broader decline in
China's capital markets.\111\
Ultimately, the cash crunch did not do much to rein in
China's debt. Once the initial scare of tight liquidity passed,
aggregate credit growth continued to rise in June and July.
Even as banks have found themselves increasingly strapped for
cash, other signs indicate that they may actually be expanding
their issuance of risky loans. Shortly after the engineered
rate spike that froze interbank lending, nearly every major
Chinese bank was selling a short-term wealth management product
(a particularly popular vehicle for financing high interest
rate, off-balance-sheet loans) that had to be completed by the
end of June.\112\ (For more on shadow banking, see chap. 1,
sec. 3, of this Report.)
Capital Account Liberalization
Beijing took moderate steps in 2013 to further open its
capital account. The primary motive was to attract foreign
investors, an indirect way to stimulate a sluggish economy.
Financial regulators launched the Qualified Foreign
Institutional Investor program in 2002 to allow licensed
foreign investors to buy and sell shares on China's stock
exchanges. China's central bank and securities regulators
approve any increase in the number of institutions and the
amount of funds that these institutions can invest in China
under the scheme. In 2013, the Qualified Foreign Institutional
Investor program saw its largest-ever increases in investment
approvals (see figure 11). Most of the approvals were given to
investors who already held Qualified Foreign Institutional
Investor licenses.
In addition to individual approvals, the quota for total
investment under the Qualified Foreign Institutional Investor
program was increased from $80 billion to $150 billion. Raising
the quota seemed relatively pointless; with total cumulative
funding approvals of $43 billion over 11 years, even the
original $80 billion quota has yet to be filled. Nonetheless,
the policy had its intended effect of generating interest among
foreign investors, as several financial services companies
quickly applied for a larger quota.*
---------------------------------------------------------------------------
* According to the Qualified Foreign Institutional Investor
program, the China Securities Regulatory Commission grants Qualified
Foreign Institutional Investor licenses and market access to foreign
investors, while the State Administration of Foreign Exchange approves
quotas for individual Qualified Foreign Institutional Investor funds.
Josh Noble, ``China Approves HSBC for Onshore Currency Investing,''
Financial Times, July 26, 2013, via Factiva database.
Figure 11: Increase in Investment Quota under the Qualified Foreign
Institutional Investor Program, January-July, 2005-2013
(US$ billions)
Source: China State Administration of Foreign Exchange, via CEIC
database.
The RMB Qualified Foreign Institutional Investor program,
first established in December 2011 to complement the Qualified
Foreign Institutional Investor program, was also expanded.
Whereas the Qualified Foreign Institutional Investor program
allows investors to bring U.S. dollars onshore and exchange
them into RMB, the RMB Qualified Foreign Institutional Investor
program allows select institutions to raise RMB offshore as
well.\113\ RMB Qualified Foreign Institutional Investor funding
approvals reached $20 billion by July 2013, four times higher
than the year before, with 34 institutions approved for
investment.\114\ The China Securities Regulatory Commission
removed rules on how quotas could be used, so that fund
managers could invest in either China's equity or domestic bond
markets without requiring separate licenses.\115\ The China
Securities Regulatory Commission also allowed units of Chinese
banks and insurers in Hong Kong--as well as other financial
institutions based in the city--to apply for RMB Qualified
Foreign Institutional Investor quotas. Previously, only the
Hong Kong units of Chinese fund management and securities
companies were allowed to invest in mainland China via the
program.\116\ In June, the RMB Qualified Foreign Institutional
Investor program was then extended beyond Hong Kong to other
offshore RMB trading centers, such as London, Singapore, and
Taiwan, to the dislike of mainland Chinese fund managers who
hoped to monopolize this new market.\117\
It is questionable, however, whether the Chinese government
is making a genuine effort to open the capital account or is
merely luring foreign investors into China to stimulate the
economy. It has done much less to open up the capital account
for Mainland investors looking to send money overseas. Chinese
domestic investors are allowed to access foreign equity markets
via pilot trustees called Qualified Domestic Institutional
Investors, which comprise banks, fund management firms,
insurance companies, dealers, and brokers approved by the China
Securities Regulatory Commission.\118\ The amount of investment
permitted for Qualified Foreign Institutional Investors barely
increased in the first half of 2013.\119\ The government
announced plans in 2012 to introduce a Qualified Domestic
Individual Investor program that would permit individuals from
the Mainland to trade Hong Kong securities directly. By October
2013, the plan had yet to proceed.\120\ The government in 2013
introduced a less ambitious Qualified Domestic Institutional
Investors scheme that would allow firms set up in the new
Qianhai special economic zone to invest a certain amount of
money in Hong Kong securities or bond markets.\121\
Excess Industrial Capacity
The Excess Capacity Crisis
In 2012-2013, China's manufacturers recorded their worst
performance since the height of the financial crisis four years
ago. Monthly growth in China's industrial production, averaging
13.3 percent in 2010, slowed to 6.1 percent in the first half
of 2013. The purchasing managers' index, a monthly survey of
manufacturers in China, consistently showed stagnation or
decline in production and orders. China's exports were also
sluggish, due to weak external demand.\122\ The construction
sector, a key source of demand for many industrial materials,
recovered slightly in the first half of 2013 from 2012 levels
but was still growing at 7 percentage points less than in 2010-
2011.\123\
The economic slump exacerbated the problem of excess
capacity in China's heavy industry. The sectors affected
extended along the value chain, from suppliers of basic
materials, such as metals and cement, to manufacturers of
ships, solar panels, and chemical additives. China today is the
world's leading producer of most of these goods. According to
official estimates, industrial enterprises in many of these
sectors were operating at only three-fifths to three-quarters
of capacity in 2012, below the Chinese government's target
minimum of 80 percent capacity (see table 2).
Table 2: Capacity Utilization in Select Chinese Industries, 2012
Capacity utilization (%)
------------------------------------------------------------------------
Capacity
Sector utilization (%)
------------------------------------------------------------------------
Chinese government target >80%
------------------------------------------------------------------------
Glass 75%
------------------------------------------------------------------------
Cement 75%
------------------------------------------------------------------------
Aluminum 73%
------------------------------------------------------------------------
Wind turbine 70%
------------------------------------------------------------------------
Steel 75%
------------------------------------------------------------------------
Solar panels 60%
------------------------------------------------------------------------
Source: Xinhua News Agency, based on official Chinese government
estimates.
Due to excess capacity, business conditions in many
industries deteriorated. In order to sell off their inventory
and attract new orders, producers slashed prices, leading
China's producer price index to contract throughout 2012-2013
(see figure 12). Some enterprises took on more debt in order to
offer generous financing terms to their customers. Shipyards,
for instance, accepted down payments of just 5 to 10 percent
for new orders, versus up to 60 percent at the high mark in
2007.\124\ To some extent, these measures proved effective--the
total losses of the industrial sector, and the total number of
loss-making industrial enterprises, declined in the first half
of 2013, after steep increases in 2012.\125\
Figure 12: Producer Price Index in China, January 2002-July 2013
Monthly (year-on-year change, %)
Source: China National Bureau of Statistics, via CEIC database.
Still, many firms incurred debts that brought them to the
brink of insolvency. Among 88 private steel enterprises, the
number of companies suffering losses grew from a third to half
in 2012-2013.\126\ In the solar sector, China's state-owned
banks grew wary of lending to panel makers after product prices
fell 66 percent in two years.\127\ Suntech Power, the world's
largest solar panel manufacturer, declared bankruptcy in March
2013 after running out of cash and defaulting on a bond payment
of more than $541 million.\128\ In the shipbuilding sector,
China Rongsheng Heavy Industries Group Holdings Ltd., a
publicly listed company and China's largest private shipyard,
sought a bailout in July from the local government in Jiangsu
Province.\129\ In its 2012 annual report, Rongsheng
acknowledged that it had only $343 million of cash and cash
equivalents to service debts of $2.7 billion.\130\
Although producers were affected by a slowing economy,
structural imbalances and ineffective government policies
created the underlying problem. China's industrial sector
remains very fragmented. For example, while Japan and South
Korea have only a few dozen large-scale shipyards, China has
some 1,650 yards of various sizes. Such industrial enterprises
have failed to coordinate production or pool resources on a
national level, creating cut-throat competition in
undifferentiated product lines. They have done so with
subsidies from local governments keen on attracting business to
grow the economy and raise government revenue. Low-interest-
rate loans from state-owned banks, with a bias toward
industrial enterprises, created additional capacity without
regard for insufficient demand. The 2009 economic stimulus
accelerated this pattern. Fixed asset investment in
manufacturing grew by an average of 35 percent in 2010-
2011.\131\ For 35 steel companies listed on the Shanghai and
Shenzhen stock exchanges, local government subsidies increased
by 128 percent year-on-year in 2010-2011.\132\ One shipbuilder,
Rongsheng, received some $550 million in local government
subsidies in 2010-2013, along with two five-year financing
deals with Export-Import Bank of China, a Chinese policy bank,
and a ten-year agreement with Bank of China, one of China's
``Big Four'' commercial banks.\133\
Reinforcing these patterns was the deliberate expansion of
productive capacity in China's poorer inland regions. In the
case of aluminum, more than 90 percent of new capacity has
emerged in western areas since 2010. Excess capacity in the
cement industry was as high as 30 percent in the Northeast and
West of the country, versus 10 to 15 percent in the more
developed eastern regions.\134\ Industrial enterprises have
relocated to where land and labor are cheaper, urban density is
lower, and local governments are less likely to enforce
environmental regulations decreed by the central
government.\135\
Some of China's industries have also fallen behind their
international competitors, who have performed better in a
difficult economic climate. In the aluminum sector, the U.S.
firm Alcoa registered profits of $191 million in 2012, while
China's aluminum giant Chinalco had a loss of $780 million, its
worst since going public in 2007.\136\ In shipbuilding, China
in 2012 received orders of $14.3 billion, its lowest order
value since 2004, while its South Korean rivals received $29.6
billion worth of new orders.\137\
Market forces are unlikely to correct the structural
problems of China's heavy industry. Heavily indebted firms
often have an incentive to maintain current output levels,
because their loans are contingent upon future output. Due to
fierce competition, there is also a concern that distributors
will turn to other producers if deliveries are cut. Because
many local communities depend on industry for employment, it is
difficult to reduce pay or shed jobs. For example, Wuhan Iron
and Steel, one of China's top-five steelmakers, supports a
workers' town of 300,000 people in Hubei Province.\138\
While such overcapacity is harmful to the affected Chinese
industries and individual businesses, as well as any
shareholders involved, it also spreads damage beyond China's
borders. Industries within the United States, such as steel and
glass, are sometimes forced to match the ``China price'' even
if it is below the cost of production, leading to business
losses and unemployment.
Tougher Policy Responses by the New Leadership
Excess capacity in China's industry is not a new problem.
The central government's restructuring of the country's state-
owned enterprises in the 1990s was partly aimed at reducing
overcapacity, particularly in the industrial northeast. The
11th Five-Year Plan (2006-2010) focused on the consolidation of
capacity, and in the 12th Five-Year Plan (2011-2015), issued in
2010, the State Council introduced a specific five-year Plan
for Industrial Transformation and Upgrading.\139\ An important
proponent of consolidation has been the NDRC, the coordinating
ministry in charge of China's industrial policy. In September
2009, it issued Document 35, ``On Restraining Excess Capacity
and Industrial Redundancy in Certain Industries.'' The document
identified industries such as steel, cement, aluminum, and
shipbuilding. It placed much of the blame on the lavish
subsidies and lax regulation of local governments and warned
that unchecked capacity expansion would eventually lead to
fierce competition and cost-cutting at the national level,
threatening the financial health of enterprises and their
creditors; depleting China's resource base; increasing reliance
on raw material imports; and worsening industrial pollution
near urban centers.\140\
However, these efforts by the government did not suffice to
check industrial expansion. Instead, industrial capacity
continued to increase under the $586 billion economic stimulus
program introduced during the global financial crisis. The EU's
Chamber of Commerce in China warned in a 60-page report in 2009
that industries such as steel, cement, and plastics were
``still blindly expanding'' despite a slump in export demand.
Referring to the steel industry, the report noted that China,
with annual production capacity of 660 million tons of steel,
and with an additional 58 million tons coming online, had sold
less than 500 million tons the previous year.\141\ With 20
million tons of primary aluminum capacity in 2008, China could
sell only 13.5 million tons, or just 68 percent of its
capacity.\142\
By the spring of 2013, during the National People's
Congress's annual meetings, top officials openly acknowledged
that excess capacity was untenable, particularly in the steel
sector. NDRC head Zhang Ping urged ``mergers and acquisitions,
eliminating backward production, and encouraging more companies
to tap into the overseas market.'' \143\ In April, the new
leadership took its first tentative steps to address the issue.
Based on a comprehensive set of criteria, including product
quality, environmental sustainability, and resource efficiency,
the Ministry of Industry and Information Technology (MIIT)
chose 45 out of a pool of 104 enterprises for consolidation of
the steel industry under the 12th Five-Year Plan. MIIT
announced that those companies that could not meet the criteria
would eventually be forced to exit the market, either by
legislative fiat or reduced access to capital.\144\
From June to August, the government's efforts to reduce
capacity intensified. The ``credit crunch'' in June, widely
attributed to China's central bank, helped to clamp down on
short-term borrowing, forcing dozens of companies to cancel or
delay bond sales, including China Development Bank, a key
backer of the shipping industry.\145\ Weeks after the credit
crunch, the central bank lifted the floor on bank lending
rates. According to economist Nicholas Lardy, at the Peterson
Institute for International Economics, the leadership used the
credit crunch and rate reform to signal that the corporate
sector would need to cut costs and improve productivity in
order to remain profitable.\146\
Beijing followed with more targeted measures aimed directly
at heavy industry. The most far-reaching measure came on July
25, when MIIT ordered more than 1,400 companies in 19
industries to permanently retire entire production lines within
factories by the end of 2013. In a break from past policy, the
government published detailed lists of exactly which plants
should reduce capacity and by how much.\147\ The lists were
downloadable from the MIIT website and included publicly listed
companies, some of which saw their share price drop as a
result.\148\ Although the industries were wide-ranging, the
companies targeted were primarily in metals, cement, and other
basic materials.\149\ MIIT reinforced these policies with
specific documents targeting the aluminum and rare earths
sectors.*
---------------------------------------------------------------------------
* MIIT in July convened several agencies, including the Environment
Ministry, Customs, the Ministry of Land and Resources, and the Ministry
of Commerce, to deliberate a new wave of crackdowns in the rare earths
industry, with a focus on rooting out illegal production through higher
fines and the closure of mines and smelting facilities. On July 24,
MIIT released new aluminum industry standards: only large alumina
projects would be authorized to use imported bauxite; alumina projects
using high-aluminum fly ash for production were to locate in a place
close to fly ash production, to reduce pollution; and the minimum
capital ratio of electrolytic aluminum projects was raised to 40
percent from the previous 35 percent, to ensure less leveraged
investments in new capacity. Shanghai Securities News, `` `Zhengzhi
fang'an' lidu kongqian: Xitu jiage fantan huo zhicheng''
(`Unprecedented Crackdown' to Support Price Rebound for Rare Earths)
July 23, 2013, p. 5; Xinhua's China Economic Information Service,
``MITT Rolls Out Policies to Resolve Excess Aluminum Capacity,'' July
24, 2013, via Factiva database.
---------------------------------------------------------------------------
On September 17, MIIT released another list for industrial
capacity retirement--the third of the year--involving a total
of 58 companies operating in 14 sectors. The affected
industries were largely the same as before, comprising steel,
coking, battery, copper smelting, zinc smelting, cement, and
plate glass, among others. Black-listed capacities were to be
demolished before the end of the year. MIIT expressly forbid
the relocation of production to the hinterland.\150\
A Lenient Approach to the Shipbuilding and Solar Photovoltaic
Industries
Although the central government took concrete steps to
rationalize production, vested interests appeared to impede
similar efforts in the shipbuilding and solar photovoltaic
sectors. A three-year plan to upgrade the country's
shipbuilding industry, released by the State Council on July
31, encouraged local governments to provide subsidies to
shipbuilders. It also offered ship-holders incentives to scrap
their ships in advance, until the end of 2015, in order to
raise demand for new ships. Banks were ordered to extend
favorable loans to overseas ship-buyers and provide credit
support to domestic ship-builders. Although the plan also
called for industry consolidation, the measures were less
targeted at individual plants.\151\
Similarly, in the ``Guidance on Promoting the Healthy
Development of the Solar Industry,'' issued on July 15, the
State Council announced new measures to spur solar panel
installations. The policy called for raising the capacity
target for solar power generation in China to 35 gigawatts (GW)
by 2015, a large step up from the 21 gigawatt target set in the
2011-2015 Solar Development Plan issued by the National Energy
Administration in 2012.\152\
The Chinese government also supported the solar industry
through an aggressive trade policy. China followed through on a
probe it launched in 2012 into alleged subsidies for U.S. and
South Korean polysilicon producers, applying antidumping duties
on these imports in July 2013. Many critics interpreted the
move as retaliation for U.S. antidumping duties leveled against
Chinese solar panel makers in September 2012. The duties also
protect China's domestic polysilicon industry, which is
suffering from overcapacity.\153\
In parallel to its rift with the United States, China
engaged in a protracted trade dispute with the European Union,
which in May 2013 threatened to apply antidumping duties on
Chinese solar panels, similar to those being enforced by the
United States.\154\ The proposed duties, averaging 47.6
percent, would have been the largest duties that the European
Union has applied to China and involved some $27 billion worth
of imports.\155\ The Chinese government made extensive efforts
to block the duties. In mid-May, the Ministry of Commerce
(MOFCOM) warned that imposing duties would ``seriously harm''
bilateral trade ties between the European Union and China.\156\
A statement posted on the Chinese government's main website on
May 30 asserted that EU member states did not all agree on the
need for the tariff duties.\157\ Premier Li Keqiang used his
first trip to Europe to encourage Germany and other major
countries to oppose the measures.\158\
China's diplomatic offensive proved effective. On June 4,
the European Commission agreed to temporarily lower the new
tariffs from the proposed level of 47.6 percent to a mere 11.8
percent, while the two sides attempted to negotiate a
solution.\159\ In late July, China scored a major victory in
the negotiations, as the European Union agreed to scrap its
proposed duties in favor of a ``price undertaking.'' The
settlement allows Chinese exporters to sell into the European
Union only enough solar panels to generate up to seven GW of
capacity each year, at a minimum price of 0.56 euros per watt.
Only Chinese firms that do not comply are subject to duties.
The outcome effectively permitted China's subsidized solar
panel exports to the European Union to continue unabated, only
at a higher sales price. As The Wall Street Journal noted, the
deal was much like the voluntary export restraints negotiated
between the Japanese and U.S. governments in the 1980s.\160\
U.S.-China Strategic and Economic Dialogue
The fifth round of the U.S.-China Strategic and Economic
Dialogue (S&ED) was held on July 10-11, 2013, in Washington,
DC. Prior to the S&ED, the United States and China held the
first meeting of the civilian-military Cyber Working Group,
where the two sides committed to work together on cooperative
activities and hold further discussions on international norms
of state behavior in cyberspace, but there were no tangible
results.\161\ Both sides agreed to hold the next meeting before
the end of 2013. (For discussion of U.S.-China tensions over
cybersecurity, see chap. 2, sec. 2, of this Report.)
On the economic front, the most relevant announcements were
(1) resumption of Bilateral Investment Treaty (BIT) talks; (2)
the launch of the Shanghai Free Trade Zone; and (3) new
measures to liberalize China's financial sector.
Announcement 1: BIT Talks Resumed
Of the economic outcomes, the most significant development
was an agreement to restart the 2008 talks to reach a BIT. Six
months before leaving office, the Bush Administration had
launched talks for a U.S.-China BIT. In November 2009,
President Obama then issued a joint statement with President Hu
Jintao, announcing plans to expedite these negotiations. Until
now, little progress has been made.\162\
At the S&ED talks, China agreed to negotiate market access
using a ``negative list'' approach (which means that all
sectors are negotiable, except for those specifically
exempted). China also agreed to grant U.S. investors national
treatment in the ``pre-establishment'' phase of investment, or
before U.S. firms are actually invested in China. This means,
for example, that China will not discriminate against U.S.
firms while they are trying to obtain a license or treat them
differently than a domestic firm.\163\
Treasury Secretary Jacob Lew described this as a
``significant breakthrough'' that ``would work to level the
playing field for American workers and businesses by opening
markets for fair competition.'' \164\ U.S. business groups
welcomed the development as a possible solution to Chinese
opposition to foreign investment in large sectors of the
Chinese economy, most notably financial services.
Others have urged caution, however. Dr. Lardy called the
BIT ``a noble goal but one which will be very difficult to
conclude in any reasonable time period and it might well
fail.'' \165\ Derek Scissors, then at the Heritage Foundation,
was similarly skeptical, noting, ``BITs are primarily about
protecting investors from discriminatory government policies.
They are not transformative instruments that change the nature
of economies, especially not large economies.'' \166\
A comprehensive BIT with China would be highly
controversial and involve protracted Senate debate over
details. BITs are treaties rather than executive agreements,*
such as the North American Free Trade Agreement, and require a
two-thirds vote of the Senate to ratify. A BIT would also
potentially curtail the powers of state and local governments
to regulate health and safety issues and even zoning, raising
sovereignty concerns. Moreover, with the exception of a few
failed deals, Chinese firms have had success investing in the
United States even without an investment treaty. Similarly,
U.S. companies have been investing in China for years, fully
cognizant of various restrictions on investment, policies that
discriminate against foreign investors in favor of Chinese
firms, and rampant intellectual property rights theft. China
may not be willing to make major concessions for a deal.
---------------------------------------------------------------------------
* Free trade agreements are generally passed under an expedited
``fast track'' rule that does not allow amendments on the floor and
calls for expedited procedures.
---------------------------------------------------------------------------
Announcement 2: Shanghai Free Trade Zone
At the S&ED talks, China also agreed to expand access to
its financial services sector for foreign investors. The most
relevant outcome involves the establishment of a pilot free
trade zone in Shanghai, which will guarantee equal access to
domestic and foreign enterprises. Led by Premier Li, the State
Council approved the plans on July 3, a week prior to the S&ED
talks. Unlike China's existing special economic zones, which
were established in the early 1980s to attract foreign
investment in manufacturing to boost exports, the Shanghai free
trade zone will not simply provide fiscal and other incentives;
it will also serve as a platform to test an assortment of
controversial market reforms.\167\
China's Ministry of Commerce approved the establishment of
the free trade zone in August 2013, touting it as a ``new path
and a new mode of opening to the outside world.'' \168\ After
months of media speculation, on September 27, 2013, the State
Council released rules to govern the new free trade zone.
Beijing has agreed to allow RMB convertibility and market-based
setting of exchange rates and interest rates, the first such
steps toward full currency convertibility.\169\ Financial
institutions in the zone would be allowed more freedom to
experiment with new products and services, which may allow
foreign firms to increase the quantity and sophistication of
financial products. The government also pledged to open up
shipping, commerce, specialized services (including legal), and
travel. Further details remain vague. No specific timeline was
given for implementing any of the reforms, though the State
Council announcement said that financial liberalization will
proceed ``as conditions allowed'' and ``risks would be
controlled,'' forestalling any suggestion of rapid change.\170\
The government announced that unlike other Chinese free
trade zones the investment at the Shanghai free trade zone will
be governed by a ``negative list'' approach. The use of the
negative list suggested that the ability of Chinese regulators
to arbitrarily constrain foreign investors might be curtailed.
However, expectations for broad reform were dampened following
the publication of this list by Shanghai government
officials.\171\ The list includes restrictions covering 18
sectors, including finance, media, utilities, property, and
manufacturing.\172\ Analysts and banking officials noted that
the wide range of restrictions reflects continued jockeying
among Chinese government officials over the speed of
liberalization.\173\ The list applies to the remainder of 2013
and will be updated as the government continues testing
liberalization policies in the free trade zone.
The South China Morning Post, a Hong Kong publication,
reported that the government would suspend some Internet
controls, granting people inside the Shanghai free trade zone
access to websites blocked elsewhere in the country, such as
Facebook and Twitter.\174\ However, the statement by the State
Council did not mention any such change. It did say foreign
companies might be allowed to offer ``specialized
telecommunications services'' in the zone, and permission to
offer services that break existing Chinese laws might be
granted on a case-by-case basis by the State Council.\175\
The new pilot zone will take up to ten years to construct
and will cover 28 square kilometers within Shanghai's existing
Waigaoqiao bonded trade zone and three other special customs
supervision zones. If successful, the model may be replicated
nationwide. In response to the Shanghai free trade zone, other
port cities, including Xiamen and Tianjin, have expressed
interest in establishing similar pilot zones.\176\
Announcement 3: Financial Sector Liberalization
As in past S&ED talks, China once again promised to move
toward a market-determined exchange rate and to submit another
proposal to join the WTO's Government Procurement Agreement.
After China was admitted to the WTO in 2001, it agreed to sign
the procurement agreement ``as soon as possible.'' However, its
first bid was only submitted in February 2008. Because the
terms of accession that China offered did not satisfy other WTO
members, China subsequently submitted two more bids, the latest
in November 2012. Three bids are generally the maximum required
for Government Procurement Agreement applicants; yet several
obstacles make China's imminent accession unlikely, not least
its huge public sector and narrow definition of procurement in
domestic law. China has resisted U.S. demands to include SOEs
as government entities that would be bound by the agreement.
China also hinted at greater market access for U.S.
financial firms, particularly in trading government bond
futures and underwriting corporate bonds. This form of foreign
participation would be conducive to China's financial sector
reform, as the government seeks novel ways to raise funds for
companies while reining in credit issued by trust companies,
local government financing vehicles, and other nontraditional
lenders. China also welcomed participation by foreign banks in
RMB settlement of cross-border trade and investment.\177\ A day
after the adjournment of the S&ED talks, China announced that
the Qualified Foreign Institutional Investor program will
expand to $150 billion (the current quota stands at $80
billion, but only $43 billion of that has been allocated for
use in investment).\178\ A similar plan for Hong Kong-based RMB
investors will grow to encompass Singapore, London, and other
cities.\179\
China's securities regulator also announced at the S&ED
talks that it will begin providing certain audit work papers to
the U.S. Securities and Exchange Commission (SEC) and the
Public Company Accounting Oversight Board, a first step toward
resolving a longstanding impasse on enforcement cooperation
related to companies that are listed in the United States. U.S.
and Chinese audit regulators also committed to accelerating
cooperation for cross-border audit oversight.\180\ However, the
S&ED joint factsheet makes no mention of a formal mechanism for
sharing audit papers, so much work remains to be done on this
issue. (For further discussion of the U.S.-China friction over
the audit issue, see chap. 1, sec. 3, of this Report.)
The U.S.-China Relationship at the WTO
On August 2, 2013, a WTO panel found that China had
violated WTO rules in applying antidumping (AD) and
countervailing duties (CVD) on U.S. exports of chicken broiler
products.* China's MOFCOM imposed AD and CVD on these products
in August and September 2010, respectively. The AD duties
ranged from 50.3 percent to 53.4 percent for the U.S. producers
who responded to MOFCOM's investigation notice, while MOFCOM
set an ``all others'' rate of 105.4 percent. In the CVD
investigation, MOFCOM imposed CVDs between 4 percent and 12.5
percent for the participating U.S. producers and an ``all
others'' rate of 30.3 percent. According to the Office of the
U.S. Trade Representative, U.S. exports to China of broiler
products fell by 80 percent following the application of the
duties.\181\ The United States brought the case in September
2011.
---------------------------------------------------------------------------
* Broiler products include most chicken products, with the
exception of live chickens and a few other products such as cooked and
canned chicken.
---------------------------------------------------------------------------
In its report, the WTO dispute settlement panel found in
favor of the United States on nearly all U.S. claims, including
substantive errors in MOFCOM's calculations and procedural
errors.\182\ The United States scored a major victory against
China's use of the average cost of production methodology in
calculating dumping margins (i.e., the difference between the
price of poultry products in the U.S. market and the price of
the same product in China). In order to estimate the cost of
production for a given chicken part, China would estimate the
average cost of producing a whole chicken and assign the cost
of producing that part depending on its weight. The United
States argued that this methodology dramatically overestimated
the cost of production for cheap parts of a chicken, such as
paws.\183\ Both sides agreed not to appeal the ruling, and it
was adopted by the WTO on September 25, 2013.
In addition to the broiler case, there are pending WTO
cases between the United States and China, whose status is
summarized in tables 3 and 4 below.
Table 3: Active WTO Cases Brought by the United States against China
--------------------------------------------------------------------------------------------------------------------------------------------------------
Appellate
No. Title Request for Panel Report Body Compliance
Consultations Report Status
--------------------------------------------------------------------------------------------------------------------------------------------------------
DS419 Measures concerning wind December 22, In consultations;
power equipment 2010 panel not yet
formed
--------------------------------------------------------------------------------------------------------------------------------------------------------
DS427 Antidumping and September 20, August 2, 2013 N/A The panel
Countervailing Duty 2011 upheld most
Measures on Broiler U.S. claims.
Products from the United The two sides
States agreed not to
appeal the
ruling
--------------------------------------------------------------------------------------------------------------------------------------------------------
DS431 Measures Related to the March 13, 2012 Panel composed
Exportation of Rare September 24,
Earths, Tungsten, and 2012; report
Molybdenum pending
--------------------------------------------------------------------------------------------------------------------------------------------------------
DS440 Antidumping and July 5, 2012 Panel composed
Countervailing Duties on February 11,
Certain Automobiles from 2013; report
the United States pending
--------------------------------------------------------------------------------------------------------------------------------------------------------
DS450 Certain Measures September 17, In consultations;
Affecting the Automobile 2012 panel not yet
and Automobile-Parts formed
Industries
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: WTO Dispute Settlement Gateway. www.wto.org.
Table 4: Active WTO Cases Brought by China against the United States
--------------------------------------------------------------------------------------------------------------------------------------------------------
Appellate
No. Title Request for Panel Report Body Compliance
Consultations Report Status
--------------------------------------------------------------------------------------------------------------------------------------------------------
DS437 Countervailing Duty May 25, 2012 Panel composed
Measures on Certain November 26,
Products from China 2012; report
\184\ pending
--------------------------------------------------------------------------------------------------------------------------------------------------------
DS449 Countervailing and September 17, Panel composed
Antidumping Measures on 2012 March 4, 2013;
Certain Products from report expected
China \185\ by December 2013
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: WTO Dispute Settlement Gateway. www.wto.org.
China's Preferential Trade Agreements
Following its accession to the WTO, China has actively
worked to negotiate and implement bilateral and multilateral
trade agreements across the globe. As China transforms from a
regional player to a global power, it has not only created a
growing web of international legal obligations but has also
gradually advanced its economic and political influence. As of
August 2013, China has signed thirteen preferential trade
agreements (PTA),* including two with Iceland and Switzerland
this year. The Iceland and Switzerland PTAs were the first
signed between China and European countries--both representing
a significant milestone in strengthening China's trade
relationship with Europe.\186\ China is currently in the
process of negotiating additional bilateral and multilateral
PTAs with neighboring and distant countries, each encompassing
particular economic and political motives (see table 5).
---------------------------------------------------------------------------
* Many PTAs negotiated by China are not comprehensive, meaning
provisions on trade in goods, services, and investment are not all
included or are signed separately. The 20 bilateral PTAs negotiated by
the United States, such as those with Chile, Costa Rica, Singapore, and
South Korea, differ markedly from the 11 negotiated by China. U.S.
agreements tend to cover more product categories and are negotiated
from the start with as comprehensive a list as possible. China's PTAs
have a narrower scope with fewer product categories.
Table 5: Preferential Trade Agreements with the PRC
----------------------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------------------
Asia-Pacific Trade Agreement (2000)
Signed
Hong Kong (2003) Macau (2003) ASEAN (2004) Chile (2005)
Trade
Pakistan (2006) New Zealand (2008) Singapore (2008) Peru (2009)
Agreements
Taiwan (2010) Costa Rica (2010) Switzerland (2013) Iceland (2013)
----------------------------------------------------------------------------------------------------------------
Norway China-Japan-Korea
Under
Australia Gulf Cooperation Council (GCC)
Negotiations
Regional Comprehensive Economic Partnership (RCEP)
----------------------------------------------------------------------------------------------------------------
Under
India Korea Colombia
Consideration
----------------------------------------------------------------------------------------------------------------
Notes: Number in parentheses indicates the year initial agreement of PTA was signed. ASEAN=Association of
Southeast Asian Nations
Source: Liu Debiao, ``Zhongguo Ziyou Maoyi Xieding Gailun'' (Introduction to China's Free Trade Agreements)
(Beijing, China: China Commerce and Trade Press, June 2012), p. 10; Ministry of Commerce, China FTA Network
(Beijing, China). http://fta.mofcom.gov.cn/topic/eniceland.shtml.
While economic development remains the focus and primary
objective of China's national policy, PTAs also serve as an
important diplomatic tool and a means to expand regional
influence and secure resources. The recently signed PTA with
Iceland, for example, was not exclusively motivated by the
reduction of barriers to trade but was likely a strategic move
by Beijing to advance its access to Arctic shipping routes
between China and Europe.\187\ Other PTAs currently under
negotiation demonstrate Beijing's desire to secure natural
resources, especially oil, which is not abundant domestically.
China is strategically advancing its domestic agenda by
negotiating trade agreements with oil-rich countries such as
Norway and international organizations such as the Gulf
Cooperation Council, an economic union of oil-rich Arab
nations.\188\
On a multilateral level, the United States and China have
diverging and competing trade initiatives, each of which
excludes the other. The U.S.-led Trans-Pacific Partnership is a
free trade agreement among 12 Pacific Rim countries. The Trans-
Pacific Partnership is based on the principles of ``open
regionalism,'' \189\ meaning that any Asia-Pacific country,
including China, is welcome to apply on the condition that
other parties to the agreement agree that it made a credible
commitment to meet the high standards of the agreement.* The
second, the China-supported Regional Comprehensive Economic
Partnership, is an initiative to link Association of Southeast
Asian Nations (ASEAN) member states and its free trade
agreement partners. The Regional Comprehensive Economic
Partnership includes China and multiple countries concurrently
participating in the U.S.-backed Trans-Pacific Partnership
negotiations, such as Australia, Japan, and New Zealand.\190\
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* At the 2011 Asia-Pacific Economic Cooperation (APEC) summit
meeting in Honolulu, Hawaii, the leaders of the (then) nine Trans-
Pacific Partnership countries agreed to the broad outlines of the
agreement. In their statement, they envisaged the Trans-Pacific
Partnership as a ``living agreement,'' meaning that it will be open to
addressing new issues as they evolve, and permit new members to join if
they are willing to sign up to its commitments. See Office of the U.S.
Trade Representative, ``Trans-Pacific Partnership (TPP) Trade
Ministers' Report to Leaders'' (Washington, DC: November 12, 2011).
http://www.ustr.gov/about-us/press-office/press-releases/2011/
november/trans-pacific-partnership-tpp-trade-ministers-%-E2-%-80-%-99-
re. The process by which new members are added has not been formalized.
The aspiring candidates have followed a process agreed to by current
members informally, with each aspiring candidate being approved with
the consensus of the other parties. In practice, the aspiring
participant must not only agree to full trade liberalization but must
also demonstrate a genuine willingness to negotiate on issues sensitive
to others and to commit to a high-standard agreement overall. See Ian
F. Ferguson et al., The Trans-Pacific Partnership Negotiations and
Issues for Congress (Washington, DC: Congressional Research Service,
August 21, 2013).
---------------------------------------------------------------------------
Negotiations on the Regional Comprehensive Economic
Partnership began in early 2013 and are to conclude by the end
of 2015.\191\ If realized, the agreement would create the
world's largest group of trading partners, accounting for about
half of the global market and about a third of the world's
economic output.\192\ The Regional Comprehensive Economic
Partnership has been seen as a move to counteract the U.S.'s
high-profile involvement and promotion of the Trans-Pacific
Partnership regional trade agreement, which has been
interpreted by the PRC as a strategy to reduce China's economic
influence in the Asia-Pacific region.\193\ Furthermore, Beijing
is leading its own regional trade agenda in Asia through the
China-South Korea, China-Australia, China-India, and the
trilateral China-Japan-South Korea negotiations, ultimately
seeking to construct a regional web of its own free trade
agreements and establish an independent ring of influence.\194\
Doing Business in China--Investment and Antitrust Challenges
Investment
China continues to adopt measures designed to encourage FDI
into the country even as FDI into China dropped from a record
$116 billion in 2011 to $111.7 billion in 2012. In the first
half of 2013, FDI into China recovered slightly to $62
billion.\195,196\ Declining optimism about the returns on
investment results from China's slowing growth rate, rising
labor costs, and regulatory conflicts. Among the major
impediments cited by American-based multinationals operating in
China are the government's favoritism toward Chinese SOEs and
private domestic firms, restrictions on foreign ownership; a
lack of regulatory transparency; inequity in licensing
processes; increased pressure to transfer technology; weak
intellectual property protection; an unreliable legal system;
and corruption on the part of government officials.\197,198\
FDI has shown signs of recovering in 2013 and was up 4.9
percent to $62 billion in the first half of the year.\199,200\
Beijing's current, targeted efforts to bolster FDI are
consistent with its history of relying on a set of measures,
including investment catalogues and tax policy, to guide FDI
inflows in accordance with development priorities set by the
CCP. China's 12th Five-Year Plan for Foreign Capital
Utilization and Overseas Investment seeks to attract higher-
quality foreign investment in designated strategic emerging
industries.* The Plan also encourages multinational
corporations to establish regional headquarters and centers for
research and development, procurement, and financial management
in China. It also indicates that China will open a variety of
sectors to foreign investors.\201\ In November 2012, Beijing
announced plans to simplify procedures for FDI, ``including new
rules under which investors will not require approval for
opening foreign currency accounts or for reinvesting foreign
exchange earnings.'' \202\ Beijing is also considering
suspending FDI-related laws and regulations in newly proposed
free-trade zones in order to encourage investments by
foreign companies and joint ventures between foreign and
Chinese companies.\203,204\ Nevertheless, concerns persist,
particularly amid high-profile Chinese antitrust and corruption
investigations, which have implicated a growing list of foreign
firms.
---------------------------------------------------------------------------
* There are seven strategic emerging industries designated in the
12th Five-Year Plan (2011-2015): (1) energy saving and environmental
protection; (2) next-generation information technology; (3)
biotechnology; (4) high-end equipment manufacturing; (5) new energy;
(6) new materials; and (7) new energy vehicles. Strategic emerging
industries benefit from preferential policies and funding.
On July 3, 2013, the State Council approved the
establishment of a free-trade zone in Shanghai, ``more akin to a free-
market zone subject to less regulation and interference than an area of
duty-free trade.'' Bloomberg, ``China to Ease Foreign Investment Rules
for New Free Trade Zones,'' August 17, 2013.
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China Targets Foreign Firms with its Antimonopoly Law
In July 2008, China enacted its Antimonopoly Law. Three
agencies = evaluate effects on competition in the marketplace,
as well as national security ramifications of corporate
practices, and other issues relevant to China's economic
development. MOFCOM is authorized to handle merger clearances;
NDRC to handle cartels and pricing conduct; and the State
Administration for Industry and Commerce (SAIC) has authority
over abuse of dominance and other non-price-related,
anticompetitive conduct. Until recently, however, only MOFCOM
was actively engaged in Anti-Monopoly Law investigation and
enforcement activities. In the five years since the law came
into effect, MOFCOM has reviewed approximately 650 mergers and
acquisitions, while NDRC has concluded about 30 cases, and SAIC
has handled only 12.\205\
---------------------------------------------------------------------------
= MOFCOM, NDRC, and the State Administration for Industry and
Commerce.
---------------------------------------------------------------------------
In recent months, the NDRC has stepped up investigations of
foreign companies suspected of price fixing, particularly the
pharmaceutical and milk powder industries. The milk powder
investigations culminated with the issuance of record fines
totaling $109 million in August 2013, after companies admitted
to entering into contracts with distributors to set a minimum
sales price for milk powder.\206,207\ U.S.-based Mead Johnson
Nutrition was issued the largest fine, RMB 204 million ($33
million) or 4 percent of the company's total revenue in
2012.\208\ The NDRC's antimonopoly bureau chief, Xu Kunlin,
told China Central Television in August that the petroleum,
telecommunications, banking, and auto industries could be
next.\209\ The State Administration for Industry and Commerce
is also stepping up its investigative efforts. As of August 15,
it is separately investigating claims of bribery, fraud, and
anticompetitive behavior in the pharmaceutical industry.\210\
Although both domestic and foreign firms have been targeted
in these investigations, there has been speculation that
Beijing is specifically targeting multinationals either in
reaction to recent antitrust cases penalizing Chinese companies
overseas or as a means of protecting domestic industry.* \211\
This speculation was bolstered by revelations that at a July
2013 Antimonopoly Law training session, NDRC officials
pressured some 30 foreign firms to confess antitrust violations
and advised them against hiring outside counsel to defend them
in investigations.\212\
---------------------------------------------------------------------------
* In March 2013, for instance, a U.S. federal district court found
North China Pharmaceutical Group and its affiliate firm to have
violated U.S. antitrust law by colluding to raise prices on vitamin C
exports to the United States. The Chinese plaintiffs were fined $162
million.
---------------------------------------------------------------------------
The broad scope of the new Antimonopoly Law makes it
difficult for foreign companies to determine whether they are
breaking the law. On July 31, 2013, Maureen Ohlhausen, head of
the U.S. Federal Trade Commission, told a Beijing audience that
she hoped Chinese competition authorities would move to
``promote predictability, fairness and transparency.'' \213\
Protecting Business Abroad--Chinese Corporate Litigation in
International and Foreign Domestic Courts
Beijing has long encouraged domestic enterprises to learn
to defend themselves in foreign markets. Under the Regulations
on Responding to Antidumping Suits (2001), the government also
authorized the Ministry of Foreign Trade and Economic
Cooperation (now a division of the Ministry of Commerce) to
coordinate companies' legal activities in order to ensure that
individual cases are harmonized with national trade policies
and objectives.\214,215\ Over the last decade, China has
increasingly initiated cases in international courts as a means
of pursuing and defending its trade and economic interests and,
in recent months, there has also been a surge in Chinese
corporate litigation in international and foreign domestic
courts, backed by official actions and statements of support.
Bringing legal challenges directly is a means for Chinese
companies to assert influence over foreign economic policies
and practices in forums not designed for state-vs.-state
litigation. The idea that corporate litigation can influence
trade and investment relationships is not novel, but Beijing's
increasing use of such litigation suggests a strategic policy
that will play an important role in China's relations with its
trading partners. It also has potentially significant
implications for China's use of trade and investment
agreements.
In 2012, in concert with Chinese government actions at the
WTO, Chinese companies successfully used European courts to
challenge and overturn CV and AD duties.* Speaking to the press
about the 2012 legal victory of Aokang Shoes in overturning
duties levied by the European Union, a spokesman for the
Chinese Ministry of Commerce said it ``boosted the confidence
of Chinese companies in protecting their interests through
legal action.'' \216\ China Daily cited the victory in a call
for Chinese companies to take ``bolder moves to defend
themselves through legal means;'' and China Central Television
featured a panel discussion of how the case could serve as an
example for dealing with international economic
challenges.\217\ Chinese companies are also employing this
strategy in the United States, as exemplified by the GPX Tire
cases brought in U.S. federal courts last year, which
supplemented Beijing's WTO actions, though less
successfully.
---------------------------------------------------------------------------
* In late 2012, Aokang Shoes, the largest private Chinese shoe
manufacturer, won a major victory when the European Court of Justice
overturned duties that the European Union had levied on imported
Chinese leather shoes in 2006. In July 2012, Zhejiang Xinan Chemical
Company, a manufacturer of the herbicide glyphosate, also won a
landmark victory at the same court on similar grounds. Both companies'
cases coincided closely with related WTO challenges brought by the
Chinese government.
In December 2011, the U.S. Court of Appeals for the
Federal Circuit ruled that the Department of Commerce had incorrectly
applied double remedies against imported tires from China's GPX
International Tire Co., because statutory and case law both dictated
that countervailing duties could not be applied to nonmarket economy
countries. (See 1984, 1988, and 1994 amendments to the United States
Tariff Act of 1930. See also Georgetown Steel Corp. v. United States,
801 F.2d 1308, Fed. Cir. 1986, where the court concluded that
countervailing duties could not be applied to nonmarket economy
countries because such duties are applied in response to subsidies; a
subsidy is a financial contribution by a government that distorts a
market; and there can be no finding of a subsidy where there is not a
market to distort). This landmark decision threw a host of open
countervailing duty investigations into limbo. Fearing that the ruling
had encouraged Chinese challenges of the application of countervailing
duties on a host of products, the U.S. Congress adopted a legislative
fix in the form of Public Law 112-99. This legislation, signed into law
on March 13, 2012, amended the Tariff Act of 1930 such that the
Department of Commerce was required to apply countervailing duties to
nonmarket economy countries where it found subsidies, and made this
requirement retroactively applicable to ``all proceedings initiated . .
. on or after November 20, 2006.''
---------------------------------------------------------------------------
Chinese companies are also beginning to bring investment-
related claims, both in foreign domestic courts and at the
International Center for the Settlement of Investment Disputes.
In foreign domestic courts, these companies are questioning
other nations' assertions of what constitutes a national
security issue and challenging the legality and
constitutionality of other countries' domestic applications of
their own laws. Ralls Corporation, for example, launched a
precedent-setting challenge to the Committee on Foreign
Investment in the United States (CFIUS), constitutional due
process claim, in response to President Obama's executive order
that it divest its investment in an Oregon wind farm.*
---------------------------------------------------------------------------
* Ralls Corporation, a U.S. subsidiary of one of China's largest
private enterprises, filed suit in U.S. district court in October 2012,
presenting a precedent-setting constitutional challenge to CFIUS and
the U.S. president. The suit was filed after the president issued an
executive order that halted the company's planned construction of four
wind farms in Oregon. The U.S. District Court for the District of
Columbia dismissed the last remaining claim in October 2013, but Ralls
is appealing the Court's decision. Earlier in 2012, Chinese-owned
Shanghai Pengxin won a protracted legal challenge to its efforts to
acquire a group of bankrupt New Zealand dairy farms, prevailing over
contentions that the acquisition might pose a threat to New Zealand's
strategic national resources.
---------------------------------------------------------------------------
At the International Center for the Settlement of
Investment Disputes, Chinese companies are employing novel and
more expansive interpretations of the investor protection
clauses in their bilateral investment treaties. For example,
China's second-largest insurer, Ping An, is currently pursuing
a $2.28 billion claim at the International Court for the
Settlement of Investment Disputes against the government of
Belgium, arguing that Belgium violated the investor protections
in the China-Belgium BIT. Though China is one of the world's
most prolific BIT negotiators, historically, its agreements
have been geared toward managing foreign investment within
China and have provided only narrow investor protections in
order to protect Beijing's sovereign authority. However, in
both the Ping An case and a prior one, Tza Yup Shum v. The
Republic of Peru (2011), Chinese companies have asserted
broader interpretations of investor protection clauses in
existing Chinese BITs in order to protect their investments
abroad.
---------------------------------------------------------------------------
In Tza Yup Shum v. The Republic of Peru (2011), Mr. Tza
successfully contended that the Peruvian regulators had violated
Peruvian law and the China-Peru Bilateral Investment Treaty in their
treatment of his investment.
---------------------------------------------------------------------------
From Beijing's perspective, these private corporate actions
may be a necessary part of a defensive strategy abroad.
According to Pu Lingchen, a partner at one of the Chinese law
firms that represented Aokang Shoes in its European court
cases, ``Without effective legal challenges against [foreign
countries'] administrative measures, the often erroneously-
applied legal articles used to defeat Chinese companies will be
taken as precedent in future cases,'' and this will encourage
other foreign markets to follow suit, attacking Chinese
products and companies without fear of retaliation.\218\ The
upshot of this new trend in Chinese corporate litigation is
that it indicates a growing reliance on the rule of law. This
is good because, as one Economist article succinctly points
out, the alternative to reliance on the law ``would likely be
escalating retaliations unrestrained by rules.'' \219\ But the
trend of Chinese corporate plaintiffs directly litigating
disputes with foreign governments also suggests a diminishing
willingness to rely on the dispute resolution mechanisms
offered by international legal regimes, which is not promising
for the navigability of the future international legal
landscape.
Implications for the United States
China's failure to rebalance its economy harms the United
States in two ways. China's emphasis on fixed investment has
created overcapacity in many industries, such as steelmaking,
which has depressed world prices and caused unemployment in the
United States and other developed countries where subsidies to
industry are few. Privately owned companies cannot compete on a
commercial basis against Chinese state-owned and state-
subsidized companies exporting goods at below the cost of
production. China's resistance to imports and foreign
investment in its financial and services sector, and its
reliance on exports to fuel economic growth, has helped to
create an enormous trade imbalance with the United States.
China's share of U.S. exports is rising slowly, benefitting a
few industries, such as carmakers and soybean growers. And yet,
the world's second-largest economy accounted for just 7 percent
of total U.S. exports in 2012, a reflection of China's
discriminatory market. The cumulative U.S. trade deficit with
China since 1979 has risen to more than $3 trillion, reducing
employment in the United States. This trade surplus represents
a claim on the productive assets of the United States.
The ASEAN-led Regional Comprehensive Economic Partnership,
supported by China, has been seen as a move to counteract the
U.S. promotion of the Trans-Pacific Partnership regional trade
agreement. The Trans-Pacific Partnership, in turn, has been
interpreted by the PRC as a strategy to reduce China's economic
influence in the Asia-Pacific region. Concurrent negotiation of
two competing Asia-Pacific trade pacts may lead to disunion
among ASEAN member states and serve as a point of contention
between the United States and China as both countries seek to
establish economic and political influence over the region.
The Chinese government's attitude toward foreign investment
creates an uncertain environment for U.S. firms. On the one
hand, in light of slowing economic growth, Beijing has
undertaken steps to reinvigorate foreign investment flows. On
the other, recent government actions appear to unfairly single
out foreign companies for scrutiny in bribery and pricing
investigations and enforcement of the Anti-Monopoly Law.
In July 2013, Chinese regulators launched a series of
antibribery and antimonopoly probes into foreign and domestic
firms. The probes began with an NDRC-led antibribery probe into
British multinational pharmaceutical firm GlaxoSmithKline.\220\
Subsequently, numerous antibribery and antimonopoly
investigations were conducted on foreign firms. China fined six
manufacturers of baby formula more than $100 million for price-
fixing, among them New Zealand's Fonterra, the world's largest
dairy company.\221\ Critics have argued that targeting foreign
companies is merely a convenient scapegoat for the government,
which is eager to assuage consumers who are upset about high
prices and questionable safety of food and medicine
products.\222\
While Chinese BITs have traditionally focused on protecting
China from foreign litigants, Chinese companies' increasing
reliance on international and foreign domestic courts to pursue
and protect investment interests abroad suggests a shift toward
a more aggressive use of investment treaties. Chinese corporate
litigants can also be expected to directly pursue grievances
against U.S. trade policies in U.S. courts with increasing
frequency, just as they are doing in other jurisdictions around
the world.
Conclusions
LChina underwent a once-a-decade leadership change
with a new president and premier and several new members of the
Politburo and Standing Committee. The leadership indicated that
China's overall economic policy goal--to transition from an
export and investment-led growth model to a greater reliance on
domestic consumption, remained the same. In reality, this
change proved difficult to implement by a new government
concerned about a slowing economy, real estate speculation,
stagnating wages, and unemployment. The incoming government
issued statements supporting a large and powerful state-owned
sector in the economy, disappointing advocates of a larger
private sector.
LThe new Chinese leadership introduced initiatives
aimed at reducing inequality, cracking down on corruption, and
promoting urbanization. There are significant impediments to
the government's ability to implement these reforms. For
example, corruption is endemic at all levels of government,
while local governments oppose urbanization due to fear that
they will be overwhelmed by a flood of new migrants.
LChina's progress in external rebalancing following
the financial crisis was only temporary and largely driven by a
weak global demand that reduced the relative size of China's
export sector. Trade data for 2012-13 show that Chinese exports
are again growing at a higher rate than imports, signaling a
continued reliance on exports to fuel economic growth and a
reversal in reducing China's massive trade surplus. As a result
of failed measures to rebalance its economy, China has
continued to expand its already record foreign currency
reserves, reaching $3.66 trillion by the end of September 2013.
LChina's trade surplus with the United States in goods
in 2012 was $315 billion, a record. For the first seven months
of 2013, China's trade surplus with the United States was $178
billion, also a record. China continues to manipulate the value
of its currency, the RMB, to achieve a competitive advantage
with the United States. China also continues to follow
mercantilist policies to foster a trade surplus with the United
States.
LChina has had little success transitioning toward a
consumption-led growth model and reducing its reliance on
massive infrastructure projects to boost economic growth.
Consequently, China's high investment levels have led to
overcapacity in multiple industries, including steelmaking,
shipbuilding, and solar panel manufacturing. A slowdown in
urban household disposable income growth and an increase in the
household savings rate have cut into consumer purchasing power
and contributed to a decline in total retail sales growth.
LChinese officials have played down the significance
of lower growth, saying the slowdown is partly due to economic
rebalancing. However, the government continues to stimulate the
economy through a variety of small steps. For example, the
State Council, China's cabinet, instituted a temporary tax cut
(scraping all value-added and operating taxes) for more than 6
million small- and medium-sized enterprises; reduced approval
procedures and administrative costs for exporting companies;
and provided more investment in railway construction in China's
central and western regions. In a similar vein, securities
regulators and the central bank issued record amounts of
investment approvals to the Qualified Foreign Institutional
Investors program.
LDue to its restrictive monetary policy, China's
central bank has accumulated the world's largest foreign
exchange reserves. The bulk of these reserves are invested in
U.S. Treasury securities, so that Chinese ownership accounts
for nearly one-quarter of foreign-owned U.S Treasuries. In
addition, China's two largest sovereign wealth funds, China
Investment Corporation and SAFE Investment Company, have
expanded their equity and real estate investments in the United
States.
LThe PRC has concluded 13 trade agreements, the latest
with Iceland and Switzerland this year--the first signed with
European governments. China is in the process of negotiating
six additional trade agreements, which include the ASEAN-led
Regional Comprehensive Economic Partnership, an initiative to
link ASEAN member states and preferential trade agreement
partners to form the world's largest trading bloc. The Regional
Comprehensive Economic Partnership, which excludes the United
States, is competing with the U.S.-led Trans-Pacific
Partnership, which excludes China. Formal negotiations of the
Regional Comprehensive Economic Partnership began in May 2013
and are scheduled to conclude by the end of 2015.
LChina's attempts to keep the value of the RMB
artificially low while strictly limiting the flow of RMB from
the country, coupled with its efforts to control a large state
banking sector, led to a banking crisis. The collapse in
liquidity threatened economic growth in China and demonstrated
the difficulty of conducting a monetary policy so at odds with
its trading partners and international norms.
LThe fifth round of the U.S.-China Strategic and
Economic dialogue was held on July 10-11, 2013, in Washington,
DC. There were no significant achievements in the strategic
track. On the economic front, the most relevant announcements
were (1) resumption of bilateral investment treaty talks; (2)
the launch of the Shanghai Free Trade Zone; and (3) new
measures to liberalize China's financial sector. In the
multilateral arena, the United States successfully challenged
China's improper imposition of antidumping and countervailing
duties at the WTO.
LChina continues to take incremental steps toward RMB
internationalization, but the goal of making the RMB a major
international currency remains out of reach as the government
continues to maintain strict controls on cross-border capital
flows.
LBeijing's efforts to reform the financial system
continue to be hampered by risky off-balance-sheet lending by
banks and nonbank financial institutions. Beijing has
undertaken efforts to curb these risky lending practices,
removing the floor on lending rates and imposing a short-term
credit crunch in a clumsy effort to send a strong signal to the
financial sector. However, there is little evidence so far that
these efforts have succeeded. The ceiling on rates paid to
depositors remains low, and some risky lending actually
increased during the credit crunch.
ENDNOTES FOR SECTION 1
1. Tom Orlik and Bob Davis, ``China Falters in Effort to Boost
Consumption,'' Wall Street Journal, July 16, 2013. http://
online.wsj.com/news/articles/
SB1000-1-4-2-4-1-2-7-8-8-7-3-2-3-6-6-4-2-0-4-5-78607340845518674?mod=wsj
_streaming_stream.
2. China's domestic consumption remains at 36 percent of GDP,
while that of the United States is 70 percent.
3. The majority of Chinese government data in this year's Annual
Report stem from CEIC database. Founded in 1992 by a team of economists
and analysts, CEIC database provides data for both developed and
developing economies around the world. CEIC is the product of Euromoney
Institutional Investor. Its China Premium database aggregates data
published by several Chinese government agencies.
4. U.S. Census Bureau, NAICS database (Washington, DC: U.S.
Department of Commerce, Foreign Trade Division, September 2013). http:/
/censtats.census.gov/cgi-bin/naic3-_-6/naicCty.pl.
5. Cheng Li, ``China's Top Future Leaders to Watch'' (Washington,
DC: The Brookings Institution, John L. Thornton China Center, profiles
of Wang Qishan and Zhang Gaoli). http://www.brookings.edu/about/
centers/china/top-future-leaders/zhang----gaoli; http://
www.brookings.edu/about/centers/china/top-future-leaders/wang----qishan.
6. Chris Buckley, ``China Takes Aim at Western Ideas,'' New York
Times, August 20, 2013; Stanley Lubman, ``Document No. 9: The Party
Attacks Western Democratic Ideals,'' Wall Street Journal China Realtime
Report blog, August 27, 2013.
7. Jane Cai, ``State-Owned Enterprises Welcome Hu Jintao's
Backing,'' South China Morning Post (Hong Kong), November 10, 2012;
Leslie Hook and Jamil Anderlini, ``Hu Jintao Reasserts Party's Tight
Grip,'' Financial Times, November 8, 2012.
8. Barry Naughton, ``Signaling Change: New Leaders Begin the
Search for Economic Reform,'' China Leadership Monitor 40 (January 14,
2013).
9. Benjamin Kang Lim and Nick Edwards, ``China's New Premier
Pledges Reform, Sees Risks,'' Reuters, March 17, 2013. http://
www.reuters.com/article/2013/03/17/us-china-parliament-
id-US-BRE-92G-02M-2013-03-17.
10. Bloomberg, ``Li Urges Paring State Role to Fuel 7.5% China
Growth,'' March 17, 2013. http: // www.bloomberg.com/news/2013-
03-17/china-s-li-vows-to-keep-7-5-growth-and-spread-
wealth-benefits.html.
11. Lingling Wei and Bob Davis, ``China Poised to Extend Central-
Bank Chief,'' Wall Street Journal, February 22, 2013.
12. Daniel Ren, ``Ex-Wealth Fund Guru Lou Jiwei to be Finance
Minister,'' South China Morning Post (Hong Kong), March 17, 2013.
13. Nerys Avery and Feiwen Rong, ``Xinhua Corrects Report on Lou's
China Growth-Target Comments,'' Bloomberg, July 2013. http://
www.bloomberg.com/news/2013-07-13/xinhua-corrects-report-on-lou-s-
china-growth-target-comments.html.
14. China Communist Party News Net, ``Liu He Will Head the Finance
and Economics Leadership Small Group Office and Be NDRC [National
Development and Reform Commission] Vice Head,'' March 26, 2013. http: /
/ renshi . people . com . cn / n / 2013 / 0326 / c139617 -
20920489.html; Caixin, ``Liu He Searching for a Chinese Road to
Reform,'' March 29, 2013. http://video.caixin.com/2013-03-29/
100508028.html.
15. Barry Naughton, ``Since the National People's Congress:
Personnel and Pro- grams of
Economic Reform Begin to Emerge,'' China Leadership Monitor 41 (June 6,
2013). http://media.hoover.org/publications/china-leadership-monitor/
article/148816.
16. World Bank, China 2030 (Washington, DC: 2012). http://
www.worldbank.org/content/dam/Worldbank/document/China-2030-
complete.pdf.
17. Kevin Hamlin, ``China Naming Harvard-Educated Liu to NDRC
[National Development and Reform Commission] May Hail Policy Shift,''
Bloomberg, March 28, 20--13. http://www.bloomberg.com/news/20--13-03-
--28/china-naming-harvard-educated -liu-to-ndrc-may-hail-policy-
shift.html.
18. Jamil Anderlini, ``China: Old barriers in way of Xi's bid for
reform,'' Financial Times, January 22, 2013.
19. State Council, ``Guanyu shenhua shouru fenpei zhidu gaige de
ruogan yijian'' (Several Opinions on Deepening the Reform of the Income
Distribution System), February 3, 2013. http://www.gov.cn/zwgk/2013-02/
05/content-_-2327531.htm.
20. Laurie Burkitt and Christopher Matthews, ``China Steps Up
Pressure on Glaxo,'' Wall Street Journal, July 16, 2013.
21. Edward Wong, ``New Communist Party Chief in China Denounces
Corruption in Speech,'' New York Times, November 19, 2012. http://
www.nytimes.com/2012/11/20/world/asia/new-communist-party-chief-in-
china-denounces-corruption.html.
22. Bo Zhiyue (senior research fellow at the East Asia Institute
of the National University of Singapore), as cited in Michael Forsythe
and Kevin Hamlin, ``China Risks Talent Mismatch as Wang Gets Discipline
Job,'' Bloomberg, November 14, 2012. http: // www.bloomberg.com/
news/2012-11-14/xi-li-named-to-communist-party-
panel-clearing-way-to-top-posts.html.
23. Economist, ``The Plot Thickens,'' September 7, 2013.
24. Michael Fortsythe, ``China State-Assets Head Removed as Graft
Inquiry Gains Pace,'' Bloomberg, September 3, 2013; Jamil Anderlini,
``Xi Jinping's Crackdown on China Corruption Follows Well-Worn Path,''
Financial Times, September 4, 2013; Financial Times, ``Net Closes on
Former China Security Chief,'' October 11, 2013. http: // www.ft.com/
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Restraining Excess Capacity and Industrial Redundancy in Certain
Industries) (Beijing, China: September 26, 2009)
141. Joe McDonald, ``Group Says Chinese Stimulus-fueled
Overinvestment Could Drive Up Exports, Strain Trade Ties,'' Associated
Press, November 26, 2009, via Factiva database.
142. Andrew Moody and Lan Lan, ``Overcapacity Exacerbated by
Recession,'' China Daily, April 12, 2010, via Factiva database.
143. Xinhua, ``China Needs to Address Industrial Overcapacity: Top
Economic Planner,'' March 11, 2013, via Factiva database.
144. Xinhua, ``Zhongguo quanmian guifan gangtie hangye huajie
guosheng channeng'' (China Comprehensively Regulates Excess Capacity
Reduction in the Steel Industry), April 2, 2013. http://
news.xinhuanet.com/fortune/2013-04/02/c----115254115.htm.
145. Manila Bulletin, ``Maritime Debt Risks Flagged by Record Cosco
Loan Yield,'' July 6, 2013, via Factiva database.
146. Nicholas Lardy, ``China Could Reform Its State Businesses by
Stealth,'' Financial Times, June 28, 2013, via Factiva database.
147. Xinhua News Agency, ``NDRC, MIIT Mull Solution to Overcapacity
in Steel, Aluminum,'' August 15, 2013, via Factiva database.
148. The only caveat was that the earlier policy on reducing steel
capacity, filed in April, meant that some companies were already braced
for the capacity reduction and had made those production lines idle for
a long time, ``China Cuts Capacity in Some Industries to
Reshape Economy,'' Bloomberg News, July 26, 2013. http://
www.-bloomberg--.--com--/--news--/--2013-----07-----25--/--china---
--cuts-----capacity-----in-some-industries-to-reshape-economy.html.
149. Ministry of Industry and Information Technology announcement,
July 26, 2013 (Beijing, China). http://www.miit.gov.cn/n11293472/
n11293832/n11293907/n11368223/15535781.html.
150. Ren Xianfang, ``China Announces New List for Industrial
Capacity Retirement,'' I H S Global Insight, September 17, 2013, via
Factiva database.
151. Xinhua's China Economic Information Service, ``China Issues 3-
Yr Plan to Upgrade Shipbuilding Industry,'' August 4, 2013, via Factiva
database.
152. Feifei Shen, ``China Confirms Goal for 35 GW of Solar Capacity
by 2015,'' Renewable Energy World.com, July 15, 2013. http://
www.renewableenergyworld.com/rea/news/article/2013/07/china-confirms-
goal-for-35-gw-of-solar-capacity-by-2015.
153. Bloomberg, ``China Imposes Duties on Polysilicon from U.S., S.
Korea,'' July 18, 2013. http://www.bloomberg.com/news/2013-07-18/china-
imposes-duties-on-poly-silicon-from-u-s-to-korea.html.
154. Leslie Hook and Joshua Chaffin, ``China Calls for Closer
Negotiations on Solar Panel Tariffs,'' Financial Times, May 9, 2013.
http://www.ft.com/intl/cms/s/0/b80ff94e-----b8c1-11e2-869f-
00144feabdc0.html?ftcamp=published----links%-2Frss%2-Fworld----asia-
pacific-_-china%2Ffeed%2F%2Fproduct#axzz2StctURz0.
155. Ethan Bilby, ``EU Warns China It Is Ready to Launch Telecoms
Dispute,'' Reuters, May 15, 2013. http://www.reuters.com/article/2013/
05/15/us-eu-trade-china-idUSBRE94E0IP20130515.
156. Reuters, ``China Says EU Solar Duties to `Seriously Harm'
Trade Ties,'' May 16, 2013. http://www.reuters.com/article--/--2013--/
--05/16/us-china-eu-solar-idUSBRE94F-0-B-D20130516.
157. Ben Blanchard, ``Chinese Media Rejects Accusation of Pressure
on EU in Solar Row,'' Reuters, May 30, 2013. http://www.reuters.com/
article/2013/05/30/us-china-eu-solar-idUSBRE94S07620130530.
158. Xinhua, ``Li Keqiang dida Bolin dui Deguo jinxing zhengshi
fangwen'' (Li Keqiang Arrives in Berlin for Official Germany Visit),
May 26, 2013. http://news.xinhuanet.com/world/2013-05/26/
c----124763749.htm.
159. Leslie Hook, Hugh Carnegy, and Scheherazade Daneshku, ``China
Launches
Investigation into EU Wine Exports,'' Financial Times, June 4, 2013. htt
p://www.-ft.-com--/--intl--/--cms--/--s--/--0--/--9229031a-----cdb1---
--11e2-----8313---
--00144feab7de.html--?--ftcamp-=--published\_\-links%-2Frss--%--2Fworld-
_-asia-----pacific-_-china%2Ffeed%2F%2Fproduct#axzz2VFWfhCDu.
160. Wall Street Journal Asia, ``The New Solar Rules,'' July 31,
2013, via Factiva database.
161. U.S. Department of State, ``U.S.-China Strategic and Economic
Dialogue V Strategic Track Select Outcomes'' (Washington, DC: July 12,
2013). http://www.state.gov/r/pa/prs/ps/2013/07/211862.htm.
162. U.S. Department of the Treasury, ``Joint U.S.-China Economic
Track Fact Sheet of the Fifth Meeting of the U.S.-China Strategic and
Economic Dialogue'' (Washington, DC: July 12, 2013). http://
www.treasury.gov/press-center/press-releases/Pages/jl2010.aspx.
163. Inside U.S.-China Trade, ``China Agrees to Key BIT Principles;
Negotiations Now Poised to Intensify,'' July 16, 2013.
164. Geoff Dyer, ``Sino-US Investment Deal Sought,'' Financial
Times, July 12, 2013. http://www.ft.com/intl/cms/s/0/83094a3e-ea76-
11e2-913c--00144feabdc0.html#-axz-z2bCdUUlvF.
165. Bob Davis, ``U.S.-China Investment Treaty: Less than Meets the
Eye,'' Wall Street Journal China RealTime Report, July 12, 2013. http:/
/blogs.wsj.com/chinarealtime/2013/07/12/u-s-china-investment-treaty-
less-than-meets-the-eye/.
166. Derek Scissors, ``An Investment Treaty with China: Don't Hold
Your Breath,'' The Heritage Foundation Foundry blog, July 12, 2013.
http://blog.heritage.org/2013/07/12/an-investment-treaty-with-china-
dont-hold-your-breath/.
167. Xinhua, ``Shanghai Ziyou Maoyi Shiyanqu Fangan Huopi Dazao
Jingji `Shengjiban' '' (Shanghai Pilot Free Trade Zone Plan Approved
Creating an Economic Upgrade), July 5, 2013. http://www.gov.cn/jrzg/
2013-07/05/content-_-2440946.htm.
168. Victoria Ruan, ``Shanghai Gets to Set Up Free-Trade Zone,''
South China Morning Post (Hong Kong), August 22, 2013; Simon Denyer,
``Creeping Reforms as China Gives Shanghai Free Trade Zone Go-Ahead,''
Wall Street Journal, August 25, 2013.
169. George Chen, ``Shanghai Free-Trade Zone to Lead on Yuan
Reform,'' South China Morning Post (Hong Kong), September 5, 2013.
170. Bob Davis and Richard Silk, ``China to Test Looser Grip on
Economy in Shanghai Free-Trade Zone,'' Wall Street Journal, September
27, 2013.
171. Shanghai Municipal People's Government, ``Zhongguo (Shanghai)
ziyou maoyi shiyan qu waishang touzi zhun ru tebie guanli
cuoshi&(fumian qingdan)'' (China [Shanghai] Pilot Free Trade Zone
Special Measures to Control Foreign Investment Access [Negative List]),
September 29, 2013. http://www.shanghai.gov.cn/shanghai/node2314/
node2319/node12344/u26ai370-36.html.
172. Richard Silk, Grace Zhu, and Liyan Qi, ``List of Restricted
Sectors for Shanghai Free-Trade Zone Published,'' Wall Street Journal,
September 29, 2013. http://online.wsj.com/article/BT-CO-20130929-
701666.html.
173. Richard Silk and Bob Davis, ``China Releases Restrictions on
Investment in Shanghai Free-Trade Zone,'' Wall Street Journal,
September 30, 2013.
174. George Chen, ``China to Lift Ban on Facebook--But Only within
Shanghai Free-Trade Zone,'' South China Morning Post (Hong Kong),
September 25, 2013.
175. Bob Davis and Richard Silk, ``China to Test Looser Grip on
Economy in Shanghai Free-Trade Zone,'' Wall Street Journal, September
27, 2013.
176. Bloomberg, ``Shanghai Economic Test Zone Lures Imitators From
China Ports,'' July 11, 2013. http://www.bloomberg.com/news/2013-07-11/
shanghai-trade-zone-test-attracts-attention-from-chinese-cities.html;
Yu Ran and Shi Jing, ``Shanghai Gets Go-ahead for Free Trade Zone,''
China Daily, July 4, 2013. http://www.chinadaily.com.cn/cndy/2013-07/
04/content-_-16722759.htm.
177. U.S. Department of the Treasury, ``U.S. Fact Sheet--Economic
Track Fifth Meeting of the U.S.-China Strategic and Economic Dialogue''
(Washington, DC: Press Release, July 12, 2013). http://
www.treasury.gov/press-center/press-releases/Pages/jl2011.aspx
178. Ding Qi and Jonathan Standing, ``UPDATE 1-China to increase
QFII quota, expand RQFII to London, Singapore--CSRC,'' Reuters, July
12, 2013.
179. Bloomberg, ``China Almost Doubles Foreign Funds' Access to
Capital Markets,'' July 12, 2013. http://www.bloomberg.com/news/2013-
07-12/china-almost-doubles-foreign-funds-access-to-capital-
markets.html.
180. For details on this issue, see U.S.-China Economic and
Security Review Commission, June 2013 Trade Bulletin (Washington, DC:
June 4, 2013). http://www.uscc.gov/trade-bulletin/june-2013-trade-
bulletin. U.S. Department of the Treasury, ``U.S. Fact Sheet--Economic
Track Fifth Meeting of the U.S.-China Strategic and Economic Dialogue''
(Washington, DC: Press Release, July 12, 2013). http://
www.treasury.gov/press-center/press-releases/Pages/jl2011.aspx.
181. Office of the U.S. Trade Representative, ``United States Wins
Trade Enforcement Case for American Farmers, Proves Export-Blocking
Chinese Duties Unjustified Under WTO Rules'' (Washington, DC: Press
Release, August 2, 2013).
182. World Trade Organization, ``China -- Anti-Dumping and
Countervailing Duty Measures on Broiler Products from the United
States,'' Dispute DS427 (Geneva, Switzerland). http://www.wto.org/
english/tratop----e/dispu----e/cases----e/ds427----e.htm#-bkmk427r.
183. Inside U.S.-China Trade, ``U.S. Wins China Poultry Dispute in
WTO, Including on `Average Cost' Method,'' August 5, 2013.
184. China's claims relate to 31 initiations of investigations or
preliminary or final determinations in 17 CVD investigations conducted
from 2007 through 2012. For a full list, see WTO, ``United States--
Countervailing Duty Measures on Certain Products from China,'' request
for consultation by China, WTO WT/DS437/1 (Geneva, Switzerland: May 30,
2012). https://docs.wto.org/dol2fe/Pages/FE----Search/FE----S----S009-
DP.aspx?language-=-E&CatalogueIdList=116469,-115003,-113669,-100434,-102
077,-38671-&-Current-Catalogue-Id-Index-=-5&FullTextSearch=.
185. China's claims relate to the imposition or collection of
duties in connection with investigations or reviews initiated between
November 20, 2006, and March 13, 2012. For a full list, see WTO,
``United States--Countervailing and Antidumping Measures on Certain
Products from China,'' request for consultations by China, WTO WT/
DS449/1 (Geneva, Switzerland: September 20, 2012). https://
docs.wto.org/dol2fe/Pages/FE----Search/FE----S----S009-
Html.aspx-?-Id-=-53282-&-Box-Number-=-3-&-Document-Part-Number-=-1&Langu
age---=---E&Window---=---L--&--PreviewContext---=---DP--&--FullTextSearc
h-=-#KV-_-GENERATED-_-FILE-_-000007.htm.
186. Shirouzu Norikiko, ``China, Switzerland Sign Free Trade
Agreement,'' Reuters, June 6, 2013. http:--//--www.reuters.com--/
--article--/--2013/07/06/us-china-trade-id-USBR-E-96503E20130706;
Xinhua, ``Chinese Premier Holds Talks with Icelandic Counterpart, FTA
Inked,'' April 15, 2013. http://news.xinhuanet.com/english/china/2013-
04/15/c----132310958.htm.
187. Economist, ``Warming Up to Iceland,'' April 17, 2013. http://
www.economist-.com/blogs/analects/2013/04/china-and-iceland.
188. J.D. Wilson, ``Resource Security and FTAs in Asia-Pacific,''
Pacific Review 25:4 (Routledge 2012): 439.
189. Ellen Frost, ``Strategic Implications of TPP [Trans-Pacific
Partnership]: Answering the Critics,'' Asia Pacific Bulletin 220
(Washington, DC: July 9, 2013): 1. http://www.eastwestcenter.org/sites/
default/files/private/apb220.pdf.
190. Sanchita Basu Das, ``RCEP [Regional Comprehensive Economic
Partnership] and TPP [Trans-Pacific Partnership]: Comparisons and
Concerns'' (Singapore: Institute of Southeast Asian Studies, January 7,
2013): 6. http://www.iseas.edu.sg/documents/publication/
ISEAS%20Perspective%202013-_-2.pdf.
191. Rohit Sinha and Geethanjali Nataraj, ``Regional Comprehensive
Economic Partnership (RCEP): Issues and Way Forward,'' Diplomat
(Tokyo), July 30, 2013. http://thediplomat.com/pacific-money/2013/
07/30/regional-comprehensive-economic-partnership-rcep-issues-and-way-
forward/.
192. Sanchita Basu Das, ``RCEP [Regional Comprehensive Economic
Partnership] and TPP [Trans-Pacific Partnership]: Comparisons and
Concerns'' (Singapore: Institute of Southeast Asian Studies, January 7,
2013): 2. http://www-.iseas.edu.sg/documents/publication/
ISEAS%20Perspective%202013-_-2.pdf.
193. Ellen Frost, ``Strategic Implications of TPP [Trans-Pacific
Partnership]: Answering the Critics,'' Asia Pacific Bulletin 220
(Washington, DC: July 9, 2013).
194. Guoyou Song and Wen Jin Yuan, ``China's Free Trade Agreement
Strategies,'' Washington Quarterly 35:4 (Fall 2012): 107-119.
195. Reuters, ``China wants fewer curbs in free trade zones to lure
foreign investment,'' August 18, 2013. http://www.reuters.com/article/
2013/08/18/us-china-investment-idUSBRE97H02Z20130818.
196. Bloomberg, ``China to Ease Foreign Investment Rules for New
Free Trade Zones,'' August 17, 2013. http://www.bloomberg.com/news/
2013-08-17/china-to-ease-free-trade-zone-laws-to-boost-foreign-
investment.html.
197. American Chamber of Commerce in China, ``China Business
Climate Survey Report, 2013.'' http://web.resource.amchamchina.org/
cmsfile/2013/03/29/0640e5a7e-0c8-f86-ff4a380150357bbef.pdf
198. U.S. Department of State, 2013 Investment Climate Statement-
China (Washington, DC: February 2013). http://www.state.gov/e/eb/rls/
othr/ics/2013/204621.htm.
199. Reuters, ``China wants fewer curbs in free trade zones to lure
foreign investment,'' August 18, 2013. http://www.reuters.com/article/
2013/08/18/us-china-investment-idUSBRE97H02Z20130818.
200. Bloomberg, ``China to Ease Foreign Investment Rules for New
Free Trade Zones,'' August 17, 2013. http://www.bloomberg.com/news/
2013-08-17/china-to-ease-free-trade-zone-laws-to-boost-foreign-
investment.html.
201. National Development and Reform Commission, 12th Five Year
Plan for Foreign Capital Utilization and Overseas Investment (Beijing,
China: July 17, 2012). http://www.sdpc.gov.cn/gzdt/
W020120724346802518900.pdf.
202. BBC News, ``China Foreign Investment Growth Hits Two-Year
High,'' July 17, 2013.
203. Reuters, ``China wants fewer curbs in free trade zones to lure
foreign investment,'' August 18, 2013. http://www.reuters.com/article/
2013/08/18/us-china-investment-idUSBRE97H02Z20130818.
204. Bloomberg, ``China to Ease Foreign Investment Rules for New
Free Trade Zones,'' August 17, 2013. http://www.bloomberg.com/news/
2013-08-17/china-to-ease-free-trade-zone-laws-to-boost-foreign-
investment.html.
205. Michael Han and Jenny Connolly, ``China's Anti-monopoly Law
celebrates fifth anniversary,'' Freshfields Bruckhaus Deringer LLP,
August 16, 2013.
206. Michael X. Y. Zhang, ``China Hands Milk Producers the Largest
Anti-Monopoly Violation Fine,'' Sheppard, Mullin, Richter & Hampton
LLP, August 21, 2013. http://www.natlawreview.com/article/china-
hands-milk-producers-largest-anti-monopoly-violation-fine
207. Kazunori Takada, ``China could target oil firms, telecoms,
banks in price probes: report,'' Reuters, August 15, 2013.
208. Michael X. Y. Zhang, ``China Hands Milk Producers the Largest
Anti-Monopoly Violation Fine,'' Sheppard, Mullin, Richter & Hampton
LLP, August 21, 2013. http://www.natlawreview.com/article/china-
hands-milk-producers-largest-anti-monopoly-violation-fine
209. Kazunori Takada, ``China could target oil firms, telecoms,
banks in price probes: report,'' Reuters, August 15, 2013.
210. Patti Waldmeir, Jamil Anderlini, and Andrew Jack, ``China
widens probe into drug pricing and corruption,'' Financial Times,
August 15, 2013.
211. Grace Ng, ``China flexing its anti-monopoly law muscle:
Revenge or self-defense?'' MedCity News, July 10, 2013.
212. CNBC, ``China sought antitrust confessions from foreign
firms,'' August 21, 2013.
213. Melissa Lipman, ``FTC [Federal Trade Commission] Commissioner
Urges China to Play it Straight on Antitrust,'' Law 360, July 31, 2013.
214. Julia Ya Qin, ``Trade, Investment and Beyond: The Impact of
WTO Accession on China's Legal System,'' in Donald C. Clarke, ed.,
China's Legal System: New Developments, New Challenges (Cambridge,
United Kingdom: Cambridge University Press, 2008).
215. People's Daily, ``China Promotes Antidumping, Antisubsidy
study,'' December 13, 2001. http://english.peopledaily.com.cn/200112/
12/eng20011212-_-86527.shtml.
216. Li Jia, ``Come out swinging: Chinese exporters are learning to
use international trade rules to defend their market power,'' News
China, February 2013.
217. China Daily, ``Bolder legal defenses needed for Chinese
companies going abroad,'' November 21, 2012; Brett Zhu, ``Trade suit
victory suggests new `Aokang Model' for Chinese Business Abroad,'' Tea
Leaf Nation, December 16, 2012.
218. Li Jia, ``Come out swinging: Chinese exporters are learning to
use international trade rules to defend their market power,'' News
China, February 2013.
219. Economist, ``When Partners Attack: China will test the WTO's
dispute-settlement system,'' February 11, 2010.
220. Patti Waldmeir and Andrew Jack, ``China Launches Drug Pricing
Probe,'' Financial Times, July 5, 2013. http://www.ft.com/intl/cms/s/0/
837e3fd6-e47e-11e2-875b-00144feabdc0.html#axzz2g0inOYh7.
221. South China Morning Post (Hong Kong), ``China Fines Milk
Powder Makers US$110m for Price-Fixing,'' August 29, 2013. http://
www.scmp.com/business/companies/article/1294898/china-fines-milk-
powder-makers-us110m-price-fixing.
222. Julien Girault, ``Foreign Firms Scapegoats in China Probes:
Analysts,'' Agence France-Presse, August 14, 2013. http://
www.foxnews.com/world/2013/08/14/foreign-firms-scapegoats-in-china-
probesanalysts/#ixzz2bwnxLH1p.
SECTION 2: TRENDS IN CHINESE
INVESTMENT IN THE UNITED STATES
Introduction
China has amassed the world's largest trove of dollar-
denominated assets. Although the true composition of China's
foreign exchange reserves, valued at $3.66 trillion, is a state
secret, outside observers estimate that about 70 percent is in
dollars.* China's concentration on accumulating dollar-
denominated assets is unusual for another reason: China's
government has deliberately adopted a conservative investment
strategy, even accepting low or negative returns on its
holdings.
---------------------------------------------------------------------------
* Official U.S. government figures show that China holds $1.28
trillion in U.S. Treasuries, making China the largest foreign holder of
U.S. Treasury securities. This figure does not include holdings of U.S.
agency or corporate debt nor does it reveal China's purchases of U.S.
Treasury securities on the secondary market or through foreign
exchanges. U.S. Department of the Treasury, ``Major Foreign Holders of
Treasury Securities'' (Washington, DC: September 17, 2013). http://
www.treasury.gov/resource-center/data-chart-center/tic/Documents/
mfh.txt.
---------------------------------------------------------------------------
In recent years, China has become less risk averse and more
willing to invest directly in U.S. land, factories, and
businesses. This trend appears to be accelerating. In June
2013, China announced its largest purchase of a U.S. asset to
date: a $7.1 billion acquisition of Virginia-based Smithfield
Foods, Inc. Given China's large holdings of U.S. dollars, China
has a huge potential for foreign direct investment
(FDI), particularly if China should substitute or
abandon portfolio investment for direct investment.
---------------------------------------------------------------------------
FDI is investment to acquire a ``long-term relationship
and reflecting a lasting interest and control'' in an enterprise
operating in an economy other than that of the investor. It is the sum
of equity capital, reinvestment of earnings, other long-term capital,
and short-term capital as shown in the balance of payments. There are
two types of FDI: inward FDI and outward FDI, resulting in a net FDI
inflow (positive or negative) and stock of FDI, which is the cumulative
number for a given period. FDI excludes most portfolio investment,
which is usually investment through the purchase of shares of an
insufficient number to allow control of the company or its board of
directors. A foreign direct investor may acquire voting power or
control of an enterprise through several methods: by incorporating a
wholly owned subsidiary or company (e.g., a ``greenfield'' investment);
by acquiring shares in an associated enterprise; through a merger or an
acquisition of an unrelated enterprise; or by participating in an
equity joint venture with another investor or enterprise. For more
information, see UNCTAD [United Nations Conference on Trade and
Development], World Investment Report 2010: Investing in a Low Carbon
Economy ``Methodological Note'' (New York and Geneva: United Nations,
2010); and World Bank, ``Foreign Direct Investment.'' http://
data.worldbank.org/indicator/BX.KLT.DINV.CD.WD.
---------------------------------------------------------------------------
This section, which draws on the Commission's May 9, 2013,
public hearing, continues the Commission's assessment of
Chinese investment in the United States. It examines the
motives and incentives driving Chinese investment, and the
sectoral and geographical distribution of Chinese investment in
the United States. The section also examines the mechanisms to
screen and monitor such investments for threats to national
security. Finally, it evaluates the proposals for reforming
such mechanisms and amending them to include a net economic
benefit test.
China's National Outward Direct Investment Strategy
While the Chinese government has been encouraging large
amounts of inward FDI to foster domestic economic growth for
decades, policies supporting outward FDI have only recently
been put in place.\1\ The Chinese government explicitly adopted
a policy encouraging Chinese companies to invest abroad in its
10th Five-Year Plan (2001-2005).\2\ The ``go out'' policy
became one of China's main development strategies and has
focused largely on Chinese state-owned enterprises (SOEs).
According to Derek Scissors, then-senior research fellow at The
Heritage Foundation, state-owned and state-controlled entities
dominate China's global outward FDI: From 2005 to 2012, SOEs
accounted for 86 percent of total outward investment, and
private entities accounted for 14 percent.\3\
The 12th Five-Year Plan (2011-2016) accelerated China's
``go out'' strategy by calling for a three-pronged approach.
First, competitive Chinese manufacturing companies should
invest overseas in order to establish international sales
networks and globally recognized brand names. Second, Chinese
companies should invest in research and development (R&D)
outside China. Finally, the plan set goals for shifting
acquisitions from sectors that support resource-intensive and
polluting manufacturing in favor of services and those sectors
that promote a cleaner, high-tech economy.\4\
The ``go out'' policy focused China's outward investment
goals on sectors in which domestic state-owned or state-
controlled firms were already intended to be dominant by policy
(the so-called ``strategic and heavyweight industries''), such
as energy, machinery, construction, and information technology
(IT).\5\ The 12th Five-Year Plan expanded this list with the
Strategic Emerging Industries, which the government has
selected for special promotion and support. The seven Strategic
Emerging Industries are energy conservation/environmental
protection, next-generation IT, biotechnology, high-end
equipment manufacturing, new energy, new materials (raw
materials), and new energy automobiles. As part of its ``go
out'' strategy, the Chinese government has developed specific
investment funds to promote outward investment in natural
resources and in fields with technological promise.\6\
According to the 12th Five-Year Plan, the contribution of
the Strategic Emerging Industries to China's gross domestic
product (GDP) is to grow from roughly 3 percent in 2010 to 8
percent by 2015 and 15 percent by 2020. The government promised
to offer financial support, promote technical innovation and
education policies, and to create a market environment to
facilitate the development of the Strategic Emerging
Industries.* With this change, China's outward FDI has expanded
from securing natural resources to include helping Chinese
companies ``upgrade their technology, pursue higher levels of
the value chain previously conceded to foreign firms, and
augment managerial skills and staffing to remain globally
competitive.'' \7\
---------------------------------------------------------------------------
* For background on the 12th Five-Year Plan generally, and the
``Strategic and Emerging Industries'' specifically, see U.S.-China
Economic and Security Review Commission, 2011 Annual Report to Congress
(Washington, DC: U.S. Government Printing Office, 2011), chapter 1,
section 4. http://www.uscc.gov/content/2011-annual-report-congress.
---------------------------------------------------------------------------
Another important goal of Chinese outward FDI is creation
and promotion of globally competitive brands. With some notable
exceptions (such as technology firm Lenovo, telecommunications
giant Huawei Technology Co. Ltd., and Haier Group, a home
appliance and consumer electronics manufacturer), Chinese
companies have stumbled in efforts to build home-grown brands
that have global recognition. The alternative strategy for many
Chinese companies looking to create global reputations has come
to mean buying strong brands abroad that already have marketing
power rather than attempting to build Chinese brands and
businesses.\8\ The aim is to create multinational companies
through acquisition, particularly in the areas that are
critical to China's economic development goals.\9\ Finally,
investment can be a crucial tool of soft power and may be used
by the Chinese government to link financial incentives
to meeting political goals or simply to burnish China's image ab
road.
The Chinese government wields many tools to encourage and
guide investment to favored companies or industries. Overseas
investments by Chinese firms require permission from the
government, because the country controls capital movements
across its borders, and such clearances are easier to receive
if the investment is in the area favored by the Chinese
government, such as food, technology, and natural
resources.\10\ Favored industries also enjoy preferential
access to financing and other benefits, making them more likely
to have incentives and opportunities to go abroad. These more
indirect policies are highly effective. For example, many
Chinese investments in the United States reflect the Strategic
Emerging Industries mentioned in the latest Five-Year Plan. In
addition, evidence is growing that the Chinese government is
using or sanctioning use of cyber espionage against private
enterprises to give companies in favored industries a
competitive edge. (For more on China's use of cyberespionage in
general, and industrial espionage in particular, see chap. 2,
sec. 2, of this Report.)
Patterns of Chinese Investment in the United States
In contrast to China's large holdings of portfolio
investment, China is still a relative newcomer when it comes to
FDI. According to official statistics from the U.S. Bureau of
Economic Analysis (BEA), in 2012, the United States attracted
$174.7 billion of global FDI, of which $219 million came from
China. For 2011, BEA estimates that flows of Chinese FDI were
valued at $576 million (with FDI stock * of $3.8 billion). A
better estimate--by country of ultimate beneficiary owner--put
stock of Chinese FDI in the United States at $9.5 billion at
the end of 2011. For the same year, China's Ministry of
Commerce (MOFCOM) estimates the flows of Chinese FDI to the
United States at $1.8 billion, with stock of FDI estimated at
around $9 billion. Despite a sustained upward trend (see figure
1), Chinese FDI accounts for less than 2 percent of total FDI
in the United States.
---------------------------------------------------------------------------
* FDI stock is the cumulative value of the capital and reserves
attributable to the parent enterprise (the investor). FDI flows
comprise capital provided by a foreign direct investor to an FDI
enterprise, or capital received from an FDI enterprise by a foreign
direct investor (these data are commonly compiled for a given period,
usually per annum). For details, see UNCTAD, World Investment Report
2010: Investing in a Low Carbon Economy ``Methodological Note'' (New
York and Geneva: United Nations, 2010). http://www.unctad.org/en/docs/
wir2010meth--en.pdf.
Unlike the standard reporting method, which attributes
each investment to the direct purchaser of record, the method known as
``country of ultimate beneficiary owner'' tracks the investment to the
actual owner.
---------------------------------------------------------------------------
Whether one uses the U.S. or Chinese figures, the official
estimates are too low (for example, just adding together the
value of the deals publicly announced in 2012, exceeds the U.S.
government's estimates for cumulative Chinese investment). One
key reason is that the estimates do not account for flows of
FDI through Hong Kong and other offshore financial centers,
such as the Cayman Islands, which are likely transit points for
Chinese money on the way to the real investment destination.
Private estimates of Chinese FDI in the United States provide
more up-to-date information but also vary depending on the
methodology used.* Dr. Scissors estimates that in 2012, China
invested over $14 billion in the United States, with cumulative
FDI between 2005 and 2012 reaching $54.2 billion. According to
estimates by the Rhodium Group, in 2012 Chinese firms invested
$6.7 billion, for a total of $23.1 billion between 2000 and
2012.
---------------------------------------------------------------------------
* The International Trade Administration (ITA), a bureau within the
U.S. Department of Commerce, stated in a 2013 report on Chinese FDI in
the United States that it is ``important to be aware of different
estimates'' of Chinese investment. ITA noted that private sector
valuations employ different definitions of FDI, data gathering
mechanisms, and accounting methods that lead to differences in reported
value of investments. See International Trade Administration, Report:
Foreign Direct Investment (FDI) in the United States from China and
Hong Kong SAR (Washington, DC: July 17, 2013). Private sector estimates
help bridge a gap that currently exists in classifying FDI by ownership
(for example, private vs. state-owned investor), as the U.S. Department
of Commerce is unable to report on company-level data for FDI in the
United States. BEA, which prepares the U.S. international transactions
accounts, is required by law to keep such company-level data
confidential.
Figure 1: Chinese FDI Stock in the United States, 2002-2011
Source: U.S. Bureau of Economic Analysis; China MOFCOM, various
years.
At the Commission's May 9, 2013, hearing, witnesses
suggested a variety of reasons for Chinese FDI into the United
States. According to Thilo Hanemann, research director of the
Rhodium Group, the recent increase in Chinese FDI in the United
States is driven by changing policies and commercial
considerations. On the policy side, Beijing has become
increasingly aware of the ``strategic vulnerability'' of having
most of its foreign exchange reserves invested in low-interest-
bearing U.S. Treasury securities and is looking to diversify
its investments. On the economic side, U.S. leadership in
technology and services has made the United States an
attractive prospect for Chinese investors seeking to ``increase
their competiveness at home and preserve access to U.S.
customers abroad.'' \11\ Mr. Hanemann noted that a related
trend is growing investment in R&D and modern service
operations such as customer service and retail: ``Those
investments complement the acquisition of advanced
manufacturing assets and allow Chinese firms to tap
into the U.S. talent base and move closer to their U.S. customer
s.'' \12\
Dr. Scissors concurred that the United States is an
attractive destination for any investment, including Chinese
investment, by virtue of its abundant land and energy assets,
technology, and skilled labor. But Dr. Scissors has identified
a more strategic dimension behind the interest of the Chinese
government in foreign investment:
There is almost surely a plan behind Chinese
investment, both globally and in the U.S. state-owned
enterprises dominate outward investment volume, making
it feasible to have a coordinated strategy beyond
simply seeking demand or higher financial return. More
specifically, Beijing has repeatedly indicated that
ownership of overseas commodities is a valuable means
of ensuring the continuous imports the [Chinese]
economy so badly needs.\13\
Andrew Szamosszegi of Capital Trade Inc. concluded in his
testimony that Chinese investment in the United States was
motivated both by market forces and by government policies and
guidance, focusing, in particular, on the Chinese government's
role as a ``gatekeeper'' in the investment approval
process.\14\ Mr. Szamosszegi also pointed out that a minor
motivating factor may be the desire by private Chinese firms
that have difficulty raising capital in China (because state-
owned banks tend to favor SOEs) to come to the United States to
take advantage of the U.S. stock exchanges. From 2007 to 2011,
more Chinese firms entered U.S. capital markets through the
purchase of listed U.S. shell companies, a technique known as a
``reverse merger,'' than through initial public offerings
(IPOs) by a ratio of three to one.\15\ (See chap. 1, sec. 3, of
this Report for fuller treatment of the reverse merger issue.)
Distribution of Investment by Sector and Ownership
In the United States, Chinese investments have emphasized
services, energy, and technology and are also notable for their
focus on brand acquisition. Examples include Lenovo's purchase
of IBM's personal computer division, and a purchase by a unit
of China Aviation Industry Corp., a state-run company, of
Cirrus Industries, a Minnesota-based company famous for its
very light jet aircraft.
Though Chinese FDI in the United States comes in a variety
of shapes and sizes, by value, it is dominated by SOEs that
closely follow the industrial policies of the Chinese
government and that tend to make far larger investments.
Private investors, which Rhodium defines as having 20 percent
or less government ownership, are more likely to be involved in
smaller deals. According to Rhodium estimates, in the years
between 2000 and 2012, state-owned companies concluded 149
deals valued at over $12.6 billion, while private companies
made 444 deals, valued at $10 billion.
Energy and services have been primary targets for Chinese
investors. Chinese FDI in the energy sector is dominated by a
few major deals by state-owned energy giants, as they pursue
know-how and technology such as fracking, which China lacks
(see figure 2). Chinese energy majors have been particularly
active in the last five years. In January 2012, Sinopec paid
$2.5 billion to Devon Energy (of Oklahoma City) for a stake in
about 1.3 million acres of drilling property in Michigan, Ohio,
and elsewhere. In February 2013, Chesapeake Energy Corp. sold a
stake to Sinopec for $1 billion in an oil and natural-gas field
straddling the Oklahoma and Kansas border. In 2010 and 2011,
China National Offshore Oil Corporation (CNOOC) bought stakes
in Chesapeake's oil and gas shale assets in south Texas for
$1.08 billion and in Colorado and Wyoming for $570 million,
respectively.
Figure 2: Cumulative Chinese FDI in the United States, by Sector,
2000-2013Q2
(total deal value $27.9 billion)
Source: Rhodium Group, China Investment Monitor (New York, NY:
2013).
Services are also playing a major role, accounting for over
a quarter of China's outward FDI value in the United States. In
this segment, a burgeoning industry is real estate, which is
favored by many Chinese investors as a more secure investment
than Chinese equities. Last year's purchases included major
investments in U.S. cities, especially San Francisco, where
China's largest developer, China Vanke Co., partnered with
Tishman Speyer Properties, a U.S. real estate business, to
build a $620 million apartment complex downtown. (Under the
deal, Vanke provides 70 percent equity, and Tishman is
responsible for the construction.)
High-tech manufacturing is another important component of
China's investments, particularly when measured in terms of the
number rather than the value of deals. Industries such as IT
and industrial equipment take top positions, reflecting Chinese
interest in U.S. technology (see figure 3).
Figure 3: Cumulative Chinese FDI in the United States, by Sector,
2000-2013Q2
(670 deals total)
Source: Rhodium Group, China Investment Monitor (New York, NY:
2013).
To date, the largest Chinese acquisition in the United
States has been the 2013 Shuanghui International Holding Ltd.'s
$7.1 billion bid (including debt assumption) for Virginia-based
Smithfield Foods Inc., the biggest U.S. pork producer.
Smithfield and Shuanghui submitted the deal voluntarily for
review by the Committee on Foreign Investment in the United
States (CFIUS), and it was cleared in early September 2013,
according to the companies (Smithfield shareholders approved
the deal on September 24, 2013).\16\ The agricultural sector
has not been an important target for Chinese FDI in the United
States so far, but it is a part of a broader trend of Chinese
global investment in farm assets or food technologies.\17\
China's acquisitions in agriculture and other sectors are being
driven by the desire to secure higher volumes of safe products
and, in the long term, access to advanced production and
processing technologies. (For a discussion of China's food
security concerns and agricultural policy, see chap. 1, sec. 4,
of this Report.)
Chinese FDI is present in most U.S. states, but states with
certain industry clusters, such as oil, gas, and automotive,
stand out among Chinese investors. According to Mr. Hanemann,
California is by far the number one destination for Chinese
investment by the number of deals, with over 170 transactions
between 2000 and 2012, or roughly one-quarter of all Chinese
FDI in the United States. Other top recipients by the number of
deals are New York, Texas, Illinois, and Michigan. These five
states account for 352 deals out of 620 concluded between 2000
and 2012. By value of deals, New York, Texas, and Virginia
lead, followed by California.\18\
China's attempts to diversify its investment away from U.S.
Treasury bonds are also evident in its investments in U.S.
private equity. For example, the State Administration of
Foreign Exchange (SAFE), which manages China's foreign exchange
holdings, has set up a New York operation to invest in private
equity, real estate, and other assets.* Unlike China Investment
Corporation (CIC), China's less publicity-shy sovereign wealth
fund, SAFE has been very secretive, so little is known about
the nature and magnitude of SAFE's deals.\19\ SAFE has been
active in buying United Kingdom (UK) property and
infrastructure and Japanese equities, according to some
analysts. Dr. Scissors estimates that SAFE's nonbond
investments in the United States total $4.5 billion, mostly in
private equity funds and similar investments. For example, in
2011, SAFE invested $500 million in a real estate private
equity fund managed by the Blackstone Group.\20\
---------------------------------------------------------------------------
* In addition to SAFE, another Chinese investment entity, China
Investment Federation, established an office in the Trump Building in
Manhattan. The group was started in the summer of 2012 with the aim of
helping Chinese investors overcome cultural, political, and logistical
hurdles to doing business in the United States. It is sponsored by DKI
Capital, a Beijing-based investment firm. Lingling Wei and Carolyn Cui,
``China is Seeking U.S. Assets,'' Wall Street Journal, May 20, 2013;
Bloomberg, ``China Said to Study U.S. Property Investments with
Reserves,'' May 27, 2013. http://www.bloomberg.com/news/2013-05-27/
china-said-to-study-investing-reserves-in-u-s-property-market.html; and
William Alden, ``A Toehold for China on Wall Street,'' New York Times,
May 17, 2013. http://dealbook.nytimes.com/2013/05/17/a-toehold-for-
china-on-wall-street/?partner=bloomberg.
Economic Security Issues Related to Chinese Investment in the United
---------------------------------------------------------------------------
States
The potential economic benefits of investment are well
known: job creation, expansion of the tax base, and improvement
in productivity and overall competitiveness. This is especially
the case for ``greenfield'' investments (i.e. investments in
which entirely new factories or businesses are created).
Mergers and acquisitions also can generate or save jobs if the
new investors revitalize ailing firms or expand local
capacities. An investment in the United States made by a
Chinese company on market-based terms free from strategic
considerations or political interference has the potential for
providing the same benefits made by any other purely economic
investor.
But as is evident from the figures, Chinese investment in
the United States is more often than not undertaken with a nod
to Chinese industrial policy goals, such as the acquisition of
valuable technology to enhance China's carefully chosen
Strategic Emerging Industries (for example, Chinese investments
in U.S. battery and solar technology). When such investments
are made by Chinese companies owned or controlled by the
government, they attract extra scrutiny for their apparent
policy goals.
Experts testifying at the Commission's May 9 hearing agreed
that the issue of the Chinese government's role in promoting
foreign investment was further complicated by the difficulty in
separating truly private Chinese companies from those under
government influence or control. For example, if a private
company in China sees that the government favors investment in
a certain industry, it will try to invest in that industry to
curry favor and take advantage of subsidies provided by the
government. Mr. Szamosszegi said that ``it would be the same as
if the government had said . . . `we want you to invest a lot
and we want you to invest in the U.S. industry.' '' \21\ Dr.
Scissors pointed out that for private firms in China ``there is
no rule of law; there is no right of refusal for private
firms'' to reject government pressure to make an
investment.\22\
Furthermore, even genuinely private companies benefit from
a slew of local and provincial government subsidies, creating
an uneven playing field for their foreign competitors. A recent
study by Usha and George Haley, U.S. researchers on China's
economy, found that Chinese steel, glass, paper, and auto parts
producers turned into global players with the benefit of local
subsidies.\23\ Another study, by Matthew Forney and Laila
Khawaja from Fathom China, a research consultancy, found that
most non-state-owned Chinese companies received some form of
direct subsidy.\24\
Witnesses at the Commission's hearing pointed out that U.S.
trade laws may not be sufficient to address negative aspects of
state-driven Chinese investment. For example, when a U.S. firm
has to obtain credit at market rates to finance its activities,
but a Chinese firm can obtain financing at minimal or even zero
interest from Chinese state-owned banks, it distorts
competition in the U.S. market. According to Elizabeth J.
Drake, partner at Stewart and Stewart, current U.S. law does
not adequately protect U.S. workers and firms from this type of
unfair competition. She noted:
Existing antitrust rules, for example, are based on
assumptions about the profit-maximizing behavior of
market actors that simply may not apply to certain
Chinese firms. In the area of predatory pricing, the
U.S. applies a recoupment test, under which pricing is
only deemed anticompetitive if the predator is likely
to eventually collect enough profits to make up for the
losses caused by the predatory behavior. . . . A
Chinese SOE, by contrast, may be able to rely on state
support to maintain losses that may never be recouped,
and engage in predatory pricing in order to gain U.S.
market share in the furtherance of political or
industrial policy goals. Such a firm could engage in
predatory pricing behavior that causes severe damage to
its U.S. competitors, but, under current law, such
behavior would not be considered anticompetitive as
long as the Chinese firm was not expected to recoup its
losses.\25\
Mr. Szamosszegi and Ms. Drake noted that one motivation for
Chinese investment may be to access markets that are otherwise
restricted by trade barriers such as tariffs or duties imposed
to counteract unfair trade practices, such as antidumping and
countervailing duties.\26\ Chinese producers are currently
subject to 121 antidumping and countervailing duty orders.
According to Mr. Szamosszegi, some Chinese firms have sought to
avoid the duty orders by shipping to the United States
illegally through third markets, while other Chinese firms from
the steel, aluminum, and solar panel industries have attempted
to invest in the United States to avoid existing trade remedy
orders or to preempt an investigation.
National Security Issues Related to Chinese Investment in the United
States
Trade-related aspects of foreign investments may intersect
with national security concerns. For example, foreign
intelligence collection efforts and espionage that target U.S.
technology, intellectual property, trade secrets, and other
proprietary information can be concealed under the seemingly
benign pretext of foreign investment in cleared government
contractors. In order to protect classified national security
information, the federal government created the National
Industrial Security Program (NISP), a program administered by
the U.S. Defense Security Service on behalf of the U.S.
Department of Defense and 25 other government agencies. This
program seeks to prevent unauthorized disclosure of classified
information, and to mitigate the threat posed by companies
determined to be under foreign ownership, control, or influence
(FOCI).* The Defense Security Service can mitigate some dangers
of such foreign investment using a specialized set of methods,
which vary from case to case (for example, altering the terms
of the deal or board membership).\27\
---------------------------------------------------------------------------
* A company is considered to be operating under FOCI whenever a
foreign interest has the power, direct or indirect, whether or not
exercised, and whether or not exercisable, to direct or decide matters
affecting the management or operations of that company in a manner that
may result in unauthorized access to classified information or may
adversely affect the performance of classified contracts. Defense
Security Service, ``Foreign Ownership, Control or Influence (FOCI)''
(Quantico, VA). http://www.dss.mil/isp/foci/foci--info.html.
---------------------------------------------------------------------------
There may be gaps, however, in the ability of the Defense
Security Service to identify and mitigate FOCI. Approximately
75 percent of NISP companies are privately held and are not
required to disclose their ownership or investor information to
an independent regulatory agency such as the Securities and
Exchange Commission. When a company enters the NISP, it must
fill out a special form,\28\ and the Defense Security Service
then attempts to verify this self-reported information. Such
verification efforts are often hampered by limited resources
and the lack of disclosure requirements to an independent
regulatory agency. Furthermore, a foreign entity could be the
primary investor in a U.S. private equity fund with ownership
in a company in the NISP without this potential influence ever
being disclosed. Such indirect ownership further complicates
analysis of possible foreign influence.
The Committee on Foreign Investment in the United States
The United States has a limited FDI screening process.
CFIUS is an interagency committee that reviews certain mergers,
acquisitions, and takeovers of U.S. businesses by foreign
persons, corporations, or governments for national security
risks. Submitting the details of an acquisition for national
security review is voluntary, but CFIUS can also initiate an
investigation on its own after a merger or acquisition of a
U.S. company by a foreigner. CFIUS can demand that the deal be
unwound or restructured on national security grounds if a deal
is considered a security risk, even after the deal has been
completed.
There is no definition of national security in the CFIUS
legislation, which allows some discretion in initiating a
review process. Screening only applies to potential mergers and
acquisitions and does not extend to greenfield investments
(i.e. a foreign entity is establishing a company or affiliate
where none exists). CFIUS also does not assess economic costs
or benefits to the United States of any given acquisition.
Several other countries, including Canada, Australia, France,
and China have screening programs similar to CFIUS that also
apply a net economic benefit test.
Among other things, CFIUS considers two elements when
evaluating whether an investment by a foreign entity warrants
an investigation: the degree of foreign state control, and
whether the transaction could affect U.S. national
security.\29\ For China, the question of state control can be
particularly complicated, because the government's role is not
always straightforward or even disclosed. Despite economic
reforms and moves toward privatization, large swathes of the
Chinese economy remain under control by various parts of the
Chinese government.\30\
In addition to outright ownership or control, the Chinese
government or the Chinese Communist Party (CCP) can also
control a publicly traded corporation by influencing the
composition of corporate boards and the corporation's
management team.\31\ Finally, it remains debatable whether
privately held Chinese corporations, especially in industries
the government deems critical, such as the Strategic Emerging
Industries, are free of state control or influence. For
example, a report by the House Intelligence Committee flagged
Chinese telecommunications-equipment makers Huawei and ZTE for
potentially providing opportunities for Chinese intelligence
services to tamper with U.S. telecommunications networks.\32\
Chinese managers often complain that their firms face
discrimination from regulators in the West. For example, Gao
Xiqing, vice chairman of CIC, complained during a visit to
Washington in April 2013 that his fund was being ``singled out
as a different investor'' by the U.S. authorities, going as far
as to say that certain people were ``slapping [us] in the face
and telling [us], OK, we don't like you.'' \33\
The perceived bias against Chinese investment has been
caused by a few failed deals and largely precipitated by
Chinese investors' confusion over U.S. regulatory structures.
In China, deals are approved in a centralized, top-down
process, but in the United States, the control and regulation
of foreign investment are decentralized. Federal regulations
are largely responsible for vetting deals on national security
grounds, with local governments, private individuals, labor
unions, nongovernmental organizations, and Congressional
leaders weighing in on various aspects of the deal. Chinese
investors often attribute the derailment of a deal due to
political or activist opposition to purposeful discrimination
by the U.S. government against Chinese investors, but in
reality it is a natural consequence of a robust democratic
process. In contrast, China has several major industries,
including finance, agriculture and telecommunications services,
walled off from foreign investors, often as part of a policy to
promote domestic companies.
U.S. regulators have blocked at least six major
acquisitions from China since 2005; however, there were
hundreds of projects (including deals done by CNOOC, known
previously for a failed 2005 bid for Unocal) that were not
rejected. Overall, despite perceptions in China, to date, the
number of Chinese deals reviewed by CFIUS has been very small
and those rejected even smaller (see figure 4).
Figure 4: Chinese Transactions Covered by CFIUS, 2006-2011
Source: Committee on Foreign Investment in the United States,
Annual Report to Congress (Washington, DC: various years).
According to the 2012 CFIUS report to Congress, in 2011,
out of 111 covered transactions, 10 were from China. Out of 114
planned and completed critical technology transactions in 2011,
China was linked to four.\34\ (For a list of select
controversial Chinese investments, see Addendum I.)
Proposals for Amending the CFIUS Mandate
At the Commission's May 9, 2013, hearing, witnesses debated
whether CFIUS should be amended to address some of the
perceived gaps in the current mandate (for example, CFIUS
cannot investigate and block greenfield investments, even those
that might pose national security threats).* Investors and
analysts frequently criticize CFIUS for the secrecy of its
reviews, the opacity of its national security criteria and
decision-making process, and its limited scope.
---------------------------------------------------------------------------
* There appear to be no federal laws or screening mechanisms that
empower the federal authorities to evaluate whether a greenfield
investment may pose a national security threat.
---------------------------------------------------------------------------
To address some of these concerns, Dr. Scissors proposed
that CFIUS develop a very narrow definition of national
security, which would make the reviews more predictable and
make it easier to understand CFIUS's actions.\35\ Dr. Scissors
advocated expanding the CFIUS mandate to include any domestic
transaction, including greenfield investments, involving a
foreign entity. Under the expanded mandate proposed by Dr.
Scissors, for example, CFIUS should be able to investigate
equipment contracts, with a particular focus on telecom
equipment in light of cybersecurity worries.\36\ Dr. Scissors
also criticized CFIUS for its extreme secrecy, arguing that a
more transparent review, with both Congress and foreign
investors receiving more information about transactions, would
enhance the credibility and accountability of the CFIUS
process.\37\
Mark Plotkin, partner, Covington & Burling, agreed that the
CFIUS review process could be made more transparent:
CFIUS today will not even acknowledge that it is
reviewing a ticket or transaction if asked. I do think
it is important for the public to know that CFIUS is
reviewing transactions. . . . The regulation of CFIUS
could be enhanced to provide more information to
foreign investors as to what kind of issues CFIUS takes
into account when CFIUS is reviewing a transaction.\38\
Ms. Drake proposed that the CFIUS review process be
expanded to include a ``net benefit test'' to review ``all
investments that are subsidized by or owned or controlled by
foreign governments. Such investment should be reviewed from
the standpoint of competitive neutrality and be reviewed for
their economic as well as national security implications.''
\39\ In other words, under her proposed revision, CFIUS would
not just screen foreign investment for national security
concerns but also for any potential economic benefit or risk to
the United States.
Mr. Plotkin, on the other hand, argued against an
introduction of a clear definition of national security under
CFIUS because it would impede CFIUS's ability to address new or
emerging problems:
That flexibility [of the definition of national
security] allows the CFIUS agencies the ability to
weigh and address their individual equities and
mandates during the course of a CFIUS review, and it
also allows CFIUS to adapt to an ever-changing threat
environment. I'd like to offer two examples of that
adaptability: cyber security and state-owned
enterprises.\40\
Similarly, Mr. Plotkin said it would be a mistake to expand
the CFIUS mandate to include a net benefit, or economic, test,
because the ``principles underlying an economic test are beyond
the core competency of CFIUS. . . . Moreover, CFIUS operates in
strict secrecy. Secrecy in the conduct of an economic benefit
test risks being perceived as protectionist.'' \41\
Implications for the United States
The federal government is responsible for national security
and has put in place a system to review transactions with
potential security implications. China presents new challenges,
because investment by SOEs can blur the line between national
security and economic security. The possibility of government
intent or coordinated strategy behind Chinese investments
raises national security worries. Recent investments by Chinese
companies in global shale oil and gas projects match Chinese
government interests in acquiring relevant technologies and
diversifying its energy mix. More broadly, Chinese companies'
attempts to acquire technology track closely the government's
plan to move up the value-added chain. There is also an
inherent tension among the different levels of government in
the United States regarding FDI from China. The federal
government tends to be concerned with maintaining national
security and protecting a rules-based, nondiscriminatory
investment regime. The state governments are more concerned
with local economic benefits, such as an expanded tax base and
increased local employment, rather than national strategic
issues, especially as job growth has stagnated.
While Chinese FDI in the United States has been quite low
so far, it has substantial room to grow. The United States
needs to be prepared to harness the benefits and address the
problems posed by Chinese funds flowing into our economy.
Though estimates vary, even the most generous assessment shows
that Chinese FDI constitutes less than 2 percent of total
inward direct investment coming to the United States. Chinese
companies are most interested in the U.S. energy, real estate,
and service sectors, particularly financial services. In
energy, as in other sectors, they are pursuing technology and
expertise they do not yet have.
If current trends continue, much of China's outward FDI, at
least in value terms, will be made by Chinese SOEs. Chinese
SOEs receive substantial benefits from the central and
provincial governments, which are not available to their
foreign competitors, including preferential policies and low
cost of capital. These SOEs are increasingly active globally,
seeking to expand China's economic reach and power around the
globe. They are involved in aerospace, autos, oil, steel,
telecommunications, and other industries that the Chinese
government has designated as strategic. U.S. companies face an
uneven playing field when competing against Chinese SOEs in the
United States and in the global market while enjoying none of
the benefits afforded to SOEs by the Chinese government.
Chinese investments in the United States are subject to the
same set of rules and regulations as investment from other
foreign countries in the areas of foreign corrupt practices,
export administration, sanctions, and antitrust. If Chinese
firms run afoul of these rules, they will be subject to legal
sanction. But gaps exist in the U.S. government's ability to
address the competitive challenges posed by SOEs.
Chinese SOEs commonly receive subsidies from central or
local governments, such as low-cost loans, loan forgiveness,
favorable regulatory and tax treatment, discounted land
purchases, free infrastructure improvements, and such inputs as
electricity or fuel at below-market rates--benefits that are
not available to U.S. competitors. By contrast, U.S. affiliates
in China operate at a distinct disadvantage in sectors where
favored Chinese SOEs enjoy extensive government support.
When companies favored by the Chinese government invest
overseas, the situation becomes more problematic. Often,
Chinese SOEs do not have to worry about making a profit,
because they can rely on government support. They need not
worry about their fiduciary obligations to their shareholders.
Instead, they are often encouraged by the government to pursue
other goals. These include resource acquisition, technology
transfer, and capturing market share, regardless of cost.\42\
Furthermore, SOEs investing in the United States may engage
in particular predatory or anticompetitive behavior that U.S.
trade remedies cannot address. For example, an SOE exporting
goods below cost to the United States can be penalized through
antidumping and countervailing duty laws. Such laws, however,
do not apply to goods made in the United States by a competitor
subsidized by the government, a practice that could leave U.S.
companies at a disadvantage at home and in third-country
markets.
Conclusions
LChinese foreign direct investment (FDI) in the United
States continues to grow, though from a very low base.
According to official U.S. statistics, in 2012 the United
States attracted $174.7 billion of global FDI, of which $219
million came from China. An estimate by country of ultimate
beneficiary owner, which better tracks actual investors, put
stock of Chinese FDI in the United States at $9.5 billion at
the end of 2011. For the same year, China's Ministry of
Commerce put the flows of Chinese FDI to the United States at
$1.8 billion, with stock of FDI estimated at around $9 billion.
LOfficial statistics underestimate the true volume of
Chinese investment, because they do not account for flows of
FDI through Hong Kong and other offshore financial centers,
which are likely transit points for Chinese money on the way to
the real investment destination. Official data are also
provided after a significant delay, which hinders analysis.
LTo date, state-owned enterprises (SOEs) have
dominated Chinese FDI in the United States measured by the
value of deals, though private companies lead by the number of
deals. One reason is that the biggest investments so far have
been made in the oil and energy fields, which are dominated by
Chinese state-owned giants.
LChinese investors have primarily targeted those
sectors where China lacks know-how and technology, particularly
in the Strategic and Emerging Industries identified in the 12th
Five-Year Plan. Energy and services (in particular real estate
and financial services) have received the most investment.
High-end manufacturing is another important destination for
China's investments, particularly when measured in terms of the
number rather than the value of deals.
LDue to the considerable government ownership of the
Chinese economy, provision by Chinese companies of critical
infrastructure to U.S. government or acquisition by Chinese
companies of U.S. firms with sensitive technology or
intellectual property could be harmful to U.S. national
interests. The Committee on Foreign Investment in the United
States (CFIUS) investigates the national security implications
of mergers and acquisitions by foreign investors of U.S.
assets.
LInvestigations by CFIUS and other national security
review and mitigation mechanisms may be hampered by limited
resources or limited statutory authority.
LInvestments made by Chinese state-owned or -
controlled companies can also pose economic security threats.
The Chinese government provides significant financial and
logistical support. This puts U.S. firms, which receive no such
support, at a competitive disadvantage. When Chinese SOEs
invest abroad, they do not necessarily seek profit and may
instead pursue government goals such as resource acquisition or
technology transfer.
LChinese investments in the United States are subject
to the same set of rules and regulations as investment from
other foreign countries in the areas of foreign corrupt
practices, export administration, sanctions, and antitrust. If
Chinese firms run afoul of these rules, they will be subject to
legal sanction. But gaps exist in the U.S. government's ability
to address the competitive challenges posed by SOEs.
LIn areas where there are no national security
considerations, and when the investment is driven by economic
rather than strategic rationale, Chinese FDI can benefit the
U.S. economy through creation of jobs and other positive
spillovers.
Addendum I: Select Controversial Chinese Investments in the United States, 1990-2013
----------------------------------------------------------------------------------------------------------------
Year Investor Target Summary
----------------------------------------------------------------------------------------------------------------
1990 China National Aero Mamco Manufacturing CFIUS found that the acquisition
Tech (CATIC) Co. of Mamco, which manufactured
machines and fabricated metal
parts for aircraft, would pose
national security risks.
Formally blocked by presidential
order.
----------------------------------------------------------------------------------------------------------------
1995 China National Non- Magnequench Inc. The initial takeover of
Ferrous Metals Magnequench, producer of high-
Import & Export tech magnets from rare-earth
Corp, San Huan, minerals, by a Chinese-led
Sextant consortium and the following
acquisition of Ugimag Inc. in
2000, received regulatory
approval from the Clinton
Administration. However, the
deal drew widespread criticism
in the U.S public for the
transfer of technology and jobs
to China when the firm's
facilities in the United States
were shut down in 2002 and 2006,
respectively.
----------------------------------------------------------------------------------------------------------------
1999 China Ocean Shipping Long-term lease of Congress banned COSCO from
(Group) Company former Naval Base, leasing a formal naval base in
(COSCO) Long Beach, CA * Long Beach through a provision
in the 1998-1999 defense
authorization bill. Legislators
cited national security concerns
as a reason for blocking the
deal through ad hoc legislative
action.
----------------------------------------------------------------------------------------------------------------
2005 China National Unocal Corp. The deal was rejected by
Offshore Oil shareholders before a CFIUS
Corporation (CNOOC) determination was made. The 2005
bid attracted significant
opposition from domestic
interest groups and Members of
Congress. After Congress
threatened to enact an amendment
that would have imposed
significant additional costs and
risks for the buyer (the Pombo
Amendment: CFIUS would be
prohibited from concluding its
national security review of an
``investment in energy assets of
a United States domestic
corporation by an entity owned
or controlled by the government
of the PRC'' until after a
period of 141 days--or 51 days
longer than the maximum of 90
days established under the Exon-
Florio Amendment), CNOOC
abandoned the bid. The U.S.
competitor Chevron ultimately
acquired Unocal.
----------------------------------------------------------------------------------------------------------------
2005 Lenovo IBM's personal Domestic interest groups, the
computer division security community, and Members
of Congress voiced concerns
after Lenovo's plans to purchase
IBM's personal computer unit
became public. The deal was
cleared by CFIUS after the
company signed extensive
security agreements.
----------------------------------------------------------------------------------------------------------------
---------------------------------------------------------------------------
* This project is included, although a lease would technically not
be counted as direct investment.
Addendum I: Select Controversial Chinese Investments in the United States, 1990-2013--Continued
----------------------------------------------------------------------------------------------------------------
Year Investor Target Summary
----------------------------------------------------------------------------------------------------------------
2008 Huawei, Bain Capital 3Com CFIUS signaled a negative
recommendation based on national
security risks posed by the sale
of network gear. Huawei and Bain
Capital withdrew the bid.
----------------------------------------------------------------------------------------------------------------
2009 Northwest Nonferrous Firstgold Corp. CFIUS signaled a negative
International recommendation based on national
Investment Co. security risks due to
Firstgold's proximity to Fallon
Naval Air Station, among other
concerns. Northwest Nonferrous
withdrew the bid.
----------------------------------------------------------------------------------------------------------------
2010 Tangshan Caofeidian Emcore CFIUS expressed concerns over
Investment Co. Ltd TCIC's acquisition of Emcore, a
(TCIC) provider of photovoltaic and
fiberoptic technology. TCIC
withdrew its bid.
----------------------------------------------------------------------------------------------------------------
2010 Far East Golden Nevada Gold After investigating the
Resources Holdings, Inc. transaction in 2012, CFIUS
Investment Ltd. proposed that Hybrid Kinetic
(FEGRI) Group Ltd (the ultimate
controlling entity of FEGRI)
divest or break up its interests
in Nevada Gold as related to the
Tempo mine site in north central
Nevada, located in proximity to
U.S. Naval Air Station Fallon.
Hybrid Kinetic and its
subsidiaries agreed to divest
all their interests in Nevada
Gold.
----------------------------------------------------------------------------------------------------------------
2011 Huawei 3Leaf CFIUS asked Huawei to submit its
purchase of assets from bankrupt
3Leaf, which created technology
for cloud computing. Huawei
agreed to divest its 3Leaf
assets after CFIUS signaled a
negative recommendation.
----------------------------------------------------------------------------------------------------------------
2012 Ralls Corp. Terna Energy Holding Ralls bought four Oregon wind
USA Corp. farm assets without reporting
the transaction to CFIUS. The
U.S. Navy objected to the
project's proximity to the
restricted Naval Weapons Systems
Training Facility airspace,
where the U.S. government tests
drones. CFIUS asked Ralls to
submit for review; upon review,
CFIUS recommended that Ralls
stop operations. Ralls
challenged the CFIUS
determination, so the president
had to formally block the deal
by executive order. Ralls
challenged the rejection with a
lawsuit alleging that the
president acted
unconstitutionally.
----------------------------------------------------------------------------------------------------------------
Addendum I: Select Controversial Chinese Investments in the United States, 1990-2013--Continued
----------------------------------------------------------------------------------------------------------------
Year Investor Target Summary
----------------------------------------------------------------------------------------------------------------
2012 Wanxiang A123 Wanxiang purchased the bankrupted
A123 at auction for $256.6
million, and the deal was
approved by CFIUS despite
significant opposition from some
Members of Congress. Wanxian
excluded A123's defense
contracts (A123's defense
division, which supplied cutting
edge batteries to the U.S.
military) from its bid at the
auction. Those were sold
separately to Illinois-based
Navitas Systems for $2.25
million. A123 has never turned a
profit and received a $249
million grant from the U.S.
Department of Energy to develop
lithium-ion batteries, although
only about half of the money was
used.
----------------------------------------------------------------------------------------------------------------
2012 CNOOC, Ltd. Nexen Inc. (U.S. In 2012 CNOOC agreed to buy Nexen
assets) Inc. (a Canadian company) for
$15.1 billion as China's largest
foreign deal. The Canadian
government's Investment Canada
Act was used to determine if the
sale provides a ``net benefit''
to Canada. In December 2012, the
sale was approved by the
Canadian federal government. In
addition to Canadian
authorities, CFIUS needed to vet
the deal because Nexen has U.S.
interests. CFIUS approval came
in February 2013.
----------------------------------------------------------------------------------------------------------------
2013 Shuanghui Smithfield Foods In June 2013, Shuanghui, China's
International Inc. largest meat processor, made an
Holdings Ltd. offer for Smithfield, the U.S.'s
biggest pork producer, for $4.7
billion in cash (including debt,
the deal values Smithfield at
$7.1 billion). Smithfield and
Shuanghui submitted the deal for
CFIUS review, even though the
food industry has not been
traditionally among those
relevant to national security.
The proposed deal attracted
opposition from some Members of
Congress as well as farm,
producer, consumer, and rural
organizations, due to worries
over food safety and the
protection of U.S. technologies
and intellectual property. CFIUS
approved the sale in early
September 2013. Smithfield
shareholders approved the deal
on September 24, 2013.
----------------------------------------------------------------------------------------------------------------
Source: Rhodium Group; various media reports.
ENDNOTES FOR SECTION 2
1. For a deeper look at the evolution of China's outbound FDI, see
Nargiza Salidjanova, ``Going Out: Overview of China's Outward Foreign
Direct Investment'' (Washington, DC: USCC Staff Research Report, March
30, 2011). http://origin.www.uscc.gov/sites/default/files/Research/
GoingOut.pdf.
2. Edward M. Graham and David M. Marchick, U.S. National Security
and Foreign Direct Investment (Washington, DC: Peterson Institute for
International Economics, May 2006), p. 100.
3. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
written testimony of Derek Scissors, May 9, 2013.
4. Ting Xu, ``Destination Unknown: Investment in China's `Go Out'
Policy,'' China Brief XI: 17 (September 16, 2011).
5. Zhao Huanxin, ``China Names Key Industries for Absolute State
Control,'' China Daily, December 19, 2006. http://
www.chinadaily.com.cn/china/2006-12/19/content_762056.htm.
6. Huang Webin and Andreas Wilkes, ``Analysis of China's overseas
investment policies'' (Bogor, Indonesia: Center for International
Forestry Research, CIFOR Working Paper 79, 2011) pp. 12-13.
7. Daniel H. Rosen and Thilo Hanemann, ``The Rise of Chinese
Overseas Investment and What It Means for American Businesses,'' China
Business Review, July 5, 2012. http: // rhg.com / articles / the-rise-
in-chinese-overseas-investment-and-what-it-means-for-american-
businesses.
8. Laurie Burkitt, ``Smithfield Deal: Past Chinese Acquisitions
Bode Well,''
Wall Street Journal, May 30, 2013. http://online.wsj.com/article/
SB100014241278873
24682204578515043950586274.html#project % 3DCBRANDS0531 % 26articleTabs
% 3D article.
9. Linda Yueh, ``China Buying Up the World?'' BBC News, May 30,
2013. http://www.bbc.co.uk/news/business-22717939.
10. For more on China's outward FDI approval process, see Andrew
Lumsden, ``Chinese Outbound Investment--The Growing Sophistication of
China's `Go Global' Policy'' (Sydney, Australia: Corrs Chambers
Westgarth, Thinking, March 18, 2013). http: // www.corrs.com.au /
thinking / insights / chinese-outbound-investment-the-growing-
sophistication-of-china-s-go-global-policy/.
11. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
written testimony of Thilo Hanemann, May 9, 2013.
12. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
written testimony of Thilo Hanemann, May 9, 2013.
13. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implication of Chinese Investment in the United States,
written testimony of Derek Scissors, May 9, 2013.
14. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implication of Chinese Investment in the United States,
written testimony of Andrew Szamosszegi, May 9, 2013.
15. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implication of Chinese Investment in the United States,
written testimony of Andrew Szamosszegi, May 9, 2013.
16. Shruti Date Singh, ``Smithfield Receives U.S. Approval for
Biggest Chinese Takeover,'' Bloomberg, September 6, 2013.
17. Luzi Ann Javier and Michelle Yun, ``Smithfield Embodies China's
Record Hunger for Farm Assets,'' Bloomberg, June 12, 2013.
18. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
testimony of Thilo Hanemann, May 9, 2013.
19. For more information about China's investment vehicles, see
U.S.-China Economic and Security Review Commission, 2008 Annual Report
to Congress (Washington, DC: U.S. Government Printing Office, 2008),
pp. 43-68. http://origin.www.uscc.gov/sites/default/files/
annual--reports/2008-Report-to-Congress--0.pdf.
20. Lingling Wei and Carolyn Cui, ``China is Seeking U.S. Assets,''
Wall Street Journal, May 20, 2013.
21. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
testimony of Andrew Szamosszegi, May 9, 2013.
22. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
testimony of Derek Scissors, May 9, 2013.
23. Usha C.V. Haley and George T. Haley, Subsidies to Chinese
Industry: State Capitalism, Business Strategy, and Trade Policy (New
York, NY: Oxford University Press, 2013).
24. Jamil Anderlini, ``Chinese Industry: Ambitions in Excess,''
Financial Times, June 16, 2013.
25. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
written testimony of Elizabeth J. Drake, May 9, 2013.
26. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
written testimony of Elizabeth J. Drake, May 9, 2013; U.S.-China
Economic and Security Review Commission, Hearing on Trends and
Implications of Chinese Investment in the United States, written
testimony of Andrew Szamosszegi, May 9, 2013.
27. For a list of FOCI mitigation instruments, see http://
www.dss.mil/isp/foci/foci--mitigation.html.
28. Standard Form 328: ``Certificate Pertaining to Foreign
Interests.'' http://www.dtic.mil/whs/directives/infomgt/forms/eforms/
sf0328.pdf.
29. Edward M. Graham and David M. Marchick, U.S. National Security
and Foreign Direct Investment (Washington, DC: Peterson Institute for
International Economics, May 2006), p. 105.
30. For more on the Chinese government's ownership and control of
the economy, see U.S.-China Economic and Security Review Commission,
2012 Annual Report to Congress (Washington, DC: U.S. Government
Printing Office, 2012), chapter 1, section 2. http://www.uscc.gov/
Annual--Reports/2012-annual-report-congress.
31. Edward M. Graham and David M. Marchick, U.S. National Security
and Foreign Direct Investment (Washington, DC: Peterson Institute for
International Economics, May 2006), p. 107.
32. U.S. House of Representatives, Permanent Select Committee on
Intelligence, Investigative Report on the U.S. National Security Issues
Posed by Chinese Telecommunications Companies Huawei and ZTE, 112th
Cong., 2nd sess., October 8, 2012. http://intelligence.house.gov/sites/
intelligence.house.gov/files/documents/Huawei-
ZTE%20Investigative%20Report%20(FINAL).pdf. Roughly half a year after
the committee's report, a senior executive from Huawei stated that his
company was no longer interested in the U.S. market after failing
repeatedly to sell its products to U.S. telecoms operators. Economist,
``You Can't Fire Me, I Quit,'' April 24, 2013. http://
www.economist.com/blogs/schumpeter/2013/04/telecoms.
33. Kasia Klimasinska, ``CIC Chief Gao Says China's Fund Treated
Differently by U.S.,'' Bloomberg Businessweek, April 25, 2013. http://
www.businessweek.com/news/2013-04-25/cic-chief-gao-says-china-s-fund-
treated-differently-by-u-dot-s-do.
34. Committee on Foreign Investment in the United States, Annual
Report to Congress (Washington, DC: December 2012). http://
www.treasury.gov/resource-center/international/foreign-investment/
Documents/ 2012 % 20CFIUS % 20Annual % 20Report % 20PUBLIC.pdf.
35. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
testimony of Derek Scissors, May 9, 2013.
36. Derek Scissors, ``A Better Committee on Foreign Investment in
the United States'' (Washington, DC: The Heritage Foundation Issue
Brief 3844, January 28, 2013).
37. Derek Scissors, ``A Better Committee on Foreign Investment in
the United States'' (Washington, DC: The Heritage Foundation Issue
Brief 3844, January 28, 2013).
38. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
testimony of Mark E. Plotkin, May 9, 2013.
39. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
testimony of Elizabeth J. Drake, May 9, 2013.
40. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
testimony of Mark E. Plotkin, May 9, 2013.
41. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
testimony of Mark E. Plotkin, May 9, 2013.
42. U.S.-China Economic and Security Review Commission, Hearing on
Trends and Implications of Chinese Investment in the United States,
testimony of Elizabeth J. Drake, May 9, 2013.
SECTION 3: GOVERNANCE AND
ACCOUNTABILITY IN CHINA'S
FINANCIAL SYSTEM
Introduction
This section provides an overview of China's financial
system, covering strains in the state banking system; the
growth of the shadow banking sector and access to credit;
market access issues and operational challenges for foreign
financial services firms; and governance, transparency and
accountability problems in China's financial sector. It is
based on witness testimonies from the Commission's March 7,
2013, hearing; information from the Commission's fact-finding
trips to China, Japan, and Taiwan; and additional staff
research.
China's Banking System and Access to Credit and Capital
China's 12th Five-Year Plan (2011-2015) calls for less
dependence on exports and state-funded infrastructure projects
and more domestic consumption to support China's economy. This
shift from government-led to private-led growth necessarily
requires that Chinese families and private sector businesses
have sufficient access to credit and capital. Private small- to
medium-sized enterprises (SMEs) already contribute 60 percent
of gross domestic product (GDP) and 80 percent of urban
employment, according to some estimates.\1,2\ Yet bank lending,
the traditional source of credit for entrepreneurs and startups
in most countries, is largely inaccessible to Chinese
individuals and SMEs, because China's financial system is
dominated by large, state-owned banks that mainly service
government-directed projects and state-owned enterprises. A
shadow banking system of unofficial credit has sprung up to
fill the gaps left by the big banks' lending practices, but it
is largely unregulated, and the proliferation of shadow banking
activity poses threats to the country's financial stability.*
---------------------------------------------------------------------------
* A shadow banking system is comprised of the unregulated or
loosely regulated lending institutions outside the more familiar model
of depository commercial banks. The shadow banking system may include
loans from insurance companies, private equity firms, hedge funds,
money market funds, venture capital firms, microlending, crowd
sourcing, off-balance sheet lending by commercial banks, and even loan
sharking.
---------------------------------------------------------------------------
Chinese State Banks
Chinese banks hold a unique position. ``In China, banks are
everything,'' said Carl Walter, former chief operating officer
of JP Morgan China and co-author of Red Capitalism, at a March
7 hearing of the Commission.\3\ The banks provide the loans and
underwrite the bonds that fund government investments in
infrastructure and fixed assets, which have been ``the major
force driving China's economic growth to near double-digit
levels over the past twenty years,'' \4\ he said. Banks in
China are even more important to the national economy than are
banks in Europe or North America, where alternative sources of
financing through equity and bond markets are available even to
small startups. In China, banks provide over 75 percent of the
nation's capital, according to the Financial Services Forum's
John Dearie, a Commission witness. By contrast, in most
developed economies, banks are a source of less than 20 percent
of capital, and in other emerging economies, banks typically
provide about 50 percent of total capital.\5\
China's financial sector is dominated by five massive,
state-owned commercial banks--the Bank of China; the Industrial
and Commercial Bank of China; the China Construction Bank; the
Agricultural Bank of China; and, to a lesser extent, the Bank
of Communications. Though they are categorized as commercial
lenders, they function more as an arm of the government. The
Commercial Bank Law of 1994 commercialized the operations of
these banks by transforming them into retail deposit and
lending institutions. The country has a network of other
commercial banks, both state owned and semiprivate, which
includes ten secondary shareholding commercial banks (the
government holds a majority of shares in most of these), a
number of city commercial banks (originally founded on the
basis of urban credit cooperatives), village and township banks
(the primary shareholders of which are often city commercial
banks), and rural credit cooperatives.* \6\ However, as Lynette
Ong of the University of Toronto explained in her testimony,
the five big, state-controlled commercial banks comprise the
heart of the banking system, collectively accounting for about
50 percent of all deposits and loans.\7\ In 2011, total assets
of commercial banking institutions were valued at renminbi
(RMB) 113.29 trillion ($16.54 trillion), with the biggest four
banks alone holding nearly 60 percent of those assets.\8\
---------------------------------------------------------------------------
* The major, second-tier shareholding commercial banks include the
Bank of Communications, China CITIC Bank, China Everbright Bank, Hua
Xia Bank, China Minsheng Bank, Guangdong Development Bank, Shenzhen
Development Bank, China Merchants Bank, Shanghai Pudong Development
Bank, and Industrial Bank.
---------------------------------------------------------------------------
Three policy banks were established in 1994 to take over
government-directed spending functions like financing of major
development projects, which were previously the purview of the
newly commercialized state banks. These state-owned policy
banks are the Agricultural Development Bank of China, China
Development Bank, and the Export-Import Bank of China.
\9\ The Chinese Communist Party (CCP) and central government
treat the policy banks as ``basic utilities'' that provide
capital to the state sector of the economy.\10\ The borrowers
are almost exclusively state sector entities undertaking state-
directed development projects, such as the construction of
dams, highways, and airports. The People's Bank of China
(PBOC), China's central bank, sets credit quotas for the big
five commercial banks, and PBOC data confirm that loans made by
these banks have also historically gone overwhelmingly to the
state sector.\11\
---------------------------------------------------------------------------
The three policy banks--the Export-Import Bank, the
Agricultural Development Bank, and the China Development Bank--were
respectively charged with promoting exports, assisting with food
production, and financing infrastructure projects. In the last decade,
the policy banks, particularly the Export-Import Bank, have expanded
their undertakings. The Export-Import Bank provides development aid and
preferential loans to foreign clients purchasing certain goods and
services from China and distributes government-backed loans to foreign
nations. Since 2007, it has had a formal, market-oriented division.
---------------------------------------------------------------------------
A 2013 Brookings Institution report outlines broad
rationales behind the big five commercial banks' lending bias,
a combination of government directives requiring them to loan
to the state sector and a greater sense of confidence on their
own part in the credit risks presented by state-owned
enterprises (SOEs). State sector borrowers often have ``strong
business positions, resulting from monopolistic or
oligopolistic power, superior business models or other
factors;'' and it seems relatively unlikely that the government
will allow a large, state-owned enterprise to default on its
loans.\12\ On the other hand, private sector businesses are
typically small, possess fewer assets that can serve as
collateral, and do not enjoy the implicit backing of the
government. As a result, the private sector enjoys almost no
assistance from China's largest commercial lending
institutions. According to an estimate by Citic Securities Co.,
only 3 percent of China's SMEs are able to get loans from these
banks. Other estimates are even lower.\13\
The policy banks and the big commercial banks are all
regulated by the China Banking Regulatory Commission. The
policy banks are funded primarily by selling bonds to the big
commercial banks, and all are ultimately guaranteed by the
Chinese government.\14\ The incestuous relationship between the
government; the large, state-owned policy banks; and their
state-owned commercial cousins provides borrowers a
considerable benefit: artificially low interest rates. PBOC
sets low interest rates for depositors as well as for
borrowers. Rates are approved by the State Council and the
CCP's Leading Group on Finance and Banking. By controlling
rates rather than allowing the market to determine them, the
government ensures that the mainly state sector borrowers are
able to access inexpensive capital, which in turn encourages
them to borrow. The banks' depositors, meanwhile, are paid very
low rates, sometimes below the rate of inflation, to help hold
down the rates charged to borrowers. Thus, the state-owned
corporate sector receives a subsidy from the bank's depositors
(Chinese households) in the form of low interest rates.
Renminbi (RMB) 36.7 trillion ($6 trillion) of household savings
are deposited into the state-owned commercial banks and receive
a savings rate of only about 3 percent. Although this is higher
than the average savings rate in the United States, the
repressive impact on Chinese household savings is compounded by
the fact that there are virtually no viable alternatives for
the average Chinese person that offer higher yields.\15,16\
Figure 1 demonstrates the outsized holdings of the large,
state-owned commercial banks. Figure 2 shows shares of loans
and deposits accounted for by various types of financial
institutions in China, also underscoring the dominance of the
five key state-owned commercial banks in China's financial
system.
Figure 1: Chinese Bank Holdings of Financial Assets, Fiscal Year 2010
* CGB--Chinese Government Bonds; MOF--Ministry of Finance; NBFI--
Nonbank financial institution; PBOC--People's Bank of China.
Source: U.S.-China Economic and Security Review Commission, Hearing
on Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Carl Walter, March 7, 2013.
Figure 2: Chinese Financial Institutions by Size of Loans and
Deposits, 2010
Figure 2: Chinese Financial Institutions by Size of Loans and
Deposits, 2010--Continued
* New rural financial institutions include township and village
banks, microcredit companies, and rural mutual aid funds.
** Others consist of nonbank finance companies and overseas banks.
*** The government owns a majority of shares in most of the second-
tier shareholding commercial banks.
Source: U.S.-China Economic and Security Review Commission, Hearing
on Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Lynette Ong, March 7, 2013.
The Stock and Bond Markets
Shareholder rights are limited in China, and many publicly
traded firms are majority owned by the government. ``Lacking
the ability to influence business choices and dividend levels,
or to sell the firm as a whole, shareowners place less reliance
on underlying firm value and focus more on likely stock price
movements in the short run.'' \17\ As a result, Chinese markets
are dominated by volatile speculative trading, and are often
compared to casinos. The two Mainland stock exchanges, the
Shanghai Stock Exchange and the Shenzhen Stock Exchange, have
undergone significant development in recent years but are not
comparable to the U.S. or European stock exchanges in scale,
importance, or regulation and still largely exclude private
Chinese enterprise. The Hong Kong exchange is the sixth-largest
exchange globally and the most popular destination for Chinese
companies seeking to list outside the Mainland, but it has a
backlog of Chinese firms waiting for approval to list.\18\
Like the state banks, China's stock markets most reliably
generate capital for the state sector.\19\ The Chinese
government uses the domestic stock markets ``to create
oligopolies and monopolies--the so-called national champions--
run by high-ranking political appointees,'' said Dr.
Walter.\20\ As with bank interest rates, the equity market
system for initial public offerings (IPOs) is controlled by the
government. The government ``literally sets the prices of new
shares based on how much funding it needs to raise, then
directs other government-controlled entities to invest.'' \21\
Equity markets ``fail to serve as a venue for capital-
raising by the private entrepreneurial companies critical for
the innovation and job creation that will be necessary for
China's long-term economic health,'' Georgetown University law
professor Paul Saulski told the Commission.\22\ An IPO is
``fundamentally a bank loan from a state-controlled bank, not
the result of a business owner selling a stake in his company
to outside investors seeking the highest return on their
capital, as we think of in the West,'' wrote Dr. Walter.\23\
Compared to the banks, the stock markets play a less
important financial role.\24\ Chinese equity financing raised a
record $123 billion on domestic and foreign exchanges in
prerecession 2007. Far larger was the $530 billion in new loans
extended by Chinese banks that year and the $581 billion in
total debt issues in the bond market.\25\ Current imbalances
are even more striking. Total debt issuance in the bond market
was approximately $1.2 trillion in 2011.\26\ Total new loans
extended by Chinese banks in 2012 were approximately $1.1
trillion.\27\ Meanwhile, IPO approvals ground to a virtual halt
in 2012 as a result of new China Securities Regulatory
Commission policies, underscoring the fact that ``IPOs in China
remain not a function of market dynamics, but of political and
institutional policies that can change both completely and
suddenly.'' \28\
One means of diversifying credit risk away from the banking
system is to encourage companies to raise funds by issuing
bonds. China's leadership seems to have recognized the
potential utility of a strong bond market and has made rapid
headway in developing one. The Chinese bond market is now the
world's fourth largest in terms of value. At approximately
$3.41 trillion (RMB 20.9 trillion), its size is surpassed only
by the United States, Japan, and France.\29\ It is also
increasingly diverse and includes both public and private debt.
But while China's bond market possesses the superficial
appearance of a modern bond market, most of the bonds issued
and traded are actually issued by other banks rather than
corporations. The corporate bond sector was valued at only RMB
548 billion ($89.7 billion), or less than 3 percent of the
Chinese bond market's total value, as of December 2012.\30\
China also has yet to develop a properly functioning municipal
bond market, and it is only beginning to develop a market for
high-yield bonds, both of which are important for attracting
investment capital. In addition, Beijing restricts foreigners
from investing in the bond markets.\31\
Strains on the Banking System
Because lending by the state-owned banks is based on
government policy decisions rather than commercial
considerations, it is not surprising that the banks have
accumulated large numbers of nonperforming loans from lending
to poorly run or poorly chosen projects undertaken by SOEs.\32\
Chinese banks appear to be undergoing a resurgence of the self-
inflicted bad debt crisis that troubled them in the late 1990s
and early 2000s.\33\
In 1999, the key Chinese state-owned commercial banks held
roughly RMB 2.5 trillion in nonperforming loans, or 31 percent
of China's annual GDP at the time. Bad loans accounted for 39
percent of Chinese banks' loans.* \34\ China's central
government created four asset management companies to bail out
the banks by disposing of their loans. The government's
recapitalization of the big banks between 1999 and 2005 removed
RMB 3 trillion ($400 billion) in bad loans, or 25 percent of
total loans, from bank balance sheets in order to compensate
for the missed loan repayments from mismanaged and unprofitable
state sector projects.\35,36\ The banks' nonperforming loans
were generally bought at full value by the asset management
companies, paid for with ten-year bonds backed by the Ministry
of Finance and loans issued to the asset management companies
by China's central bank.\37\ The central government also
launched a variety of other initiatives aimed at curbing the
big banks' substandard lending and maintaining asset quality.
By the end of 2008, the nonperforming loan ratios of commercial
banks had dropped to 2.4 percent of the total.\38,39\
---------------------------------------------------------------------------
* By comparison, Spanish banks' bad loan ratio reached a record
high of 12 percent in 2013 as a result of the recession there. The
average nonperforming loan ratio for all U.S. banks between 1999 and
2009 was 1.67 percent, according to the Federal Reserve, and is
currently 3.16 percent. At the height of the financial crisis, the
average nonperforming loan ratio for all U.S. banks was nearly 6
percent. ``Banking Brief for Pennsylvania, New Jersey and Delaware,''
Philadelphia Fed, First Quarter 2011. http://www.philadelphiafed.org/
research-and-data/publications/banking-brief/2011/BB1Q2011.pdf; Charles
Penty & Emma Ross-Thomas, ``Spanish Banks' Bad Loans Ratio Climbs to
Record 12.1%,'' Bloomberg, October 8, 2013. http://www.bloomberg.com/
news/2013-10-18/spanish-banks-bad-loans-ratio-climbs-to-record-12-
1-.html.
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With the Chinese government's response to the global
financial crisis, however, the strain of nonperforming loans
has returned. Although financial statements provided by
international auditing companies show the banks' current
nonperforming loan ratios at less than 1 percent, this figure
only covers loans that are on the balance sheets, and it
strains credulity in light of the banks' central role in
carrying out the government's stimulus response to the global
economic crisis.\40\ In November 2008, the central government
announced a $652 billion (in current dollars) stimulus, the
equivalent of 12.5 percent of China's GDP that year, and
directed the banks to fund the bulk of it by granting loans for
infrastructure projects.\41\ According to analysis by KPMG, a
multinational accounting firm, ``Banks extended RMB 9.6
trillion worth of new loans'' in 2009, ``more than twice the
total lending in 2008,'' and RMB 8.0 trillion in 2010.\42\ As
the Chinese economy responded, the banks kept boosting their
lending. The International Monetary Fund (IMF) estimates that
Beijing has relied on the big banks to issue at least $3.8
trillion (RMB 23.4 trillion) in new loans since 2008 to help
offset the impact of the global economic crisis on the Chinese
economy. Dr. Walter estimated that the unofficial shortfall
``could be anywhere from $1 trillion (RMB 6.2 trillion) to $2.3
trillion (RMB 14.2 trillion) against bank capital of $400
billion.'' \43\ As one financial journalist noted, ``Either the
Chinese government has become extremely skilled at lending in a
very short time, and Chinese borrowers have become even better
at repaying, or the numbers are too good to be true.'' \44\
Meanwhile, there are questions about whether the asset
management companies (AMC) could be used to aid another bank
recapitalization. Though at least two of them claim to be
profitable today, other evidence strongly suggests that they
are still holding a significant amount of the debt they took on
in 1999. According to one unnamed financial expert who spoke to
The Economist, they ``seem to be virtual holding-tanks where
the debt doesn't stay and doesn't depart either.'' There is
speculation that they are insolvent.* \45\
---------------------------------------------------------------------------
* The four asset management companies established to dispose of the
banks' nonperforming loans are Orient AMC (which serviced the Bank of
China), Great Wall AMC (which serviced the Agricultural Bank of China),
Huarong AMC (which serviced the Industrial and Commercial Bank of
China), and Cinda AMC (which serviced the China Construction Bank). It
is not entirely clear how much the asset management companies have
recovered, but in 2009 the ten-year bonds were extended an additional
ten years to assist in continued recovery, indicating that the 1999
bank bailout is very much an ongoing job. As of December 2012, Orient
AMC had reportedly disposed of $37 billion of these nonperforming
assets and recovered $8 billion, achieving a cash recovery ratio of
21.90 percent. Both Huarong and Cinda claim to be making profits, but
their claims are not verified.
---------------------------------------------------------------------------
The lending binge has raised fears of impending inflation
and ushered in a clampdown on lending in 2012 and 2013, ``with
harsh quotas that have made credit available only to those SOEs
least likely to default.'' \46\ For example, bank lending to
local government financing vehicles has been curtailed.
Local government financing vehicles are companies set up by
local governments to facilitate borrowing from state banks,
which allows them to spend beyond the limits of their budgets.
There are currently more than 10,000 local government financing
vehicles in China. These hidden and unregulated companies have
been ``the unseen hand powering China's investment-led economic
growth over the past decade.'' \47\ Bank lending to local
government financing vehicles rose from ``RMB 1.7 trillion in
outstanding loans at the beginning of 2008 to nearly RMB 5
trillion just two years later.'' \48\ In December 2012,
outstanding loans to local government financing vehicles
reached an estimated RMB 9.2 trillion ($1.4 trillion). The
China Banking Regulatory Commission and the Chinese Ministry of
Finance began instituting limits on future issuances, first
barring local governments from using public assets as loan
guarantees on behalf of their financing vehicles and then
announcing that new loans extended to local government
financing vehicles must be covered by existing cash flows and
that the projects they are used for must generate returns.\49\
Approximately one-third of the outstanding loans to local
government financing vehicles are scheduled to come due in the
next three years, and ``there are well documented concerns that
many of the underlying projects offer insufficient cash
generating ability to service the incumbent debt.'' \50\ To
avoid potential defaults, banks have begun extending maturities
for local governments.\51\
---------------------------------------------------------------------------
Local governments are not permitted to borrow directly
from state banks and also are generally not permitted to issue
municipal bonds under the 1995 People's Republic of China algorithm law
(Chapter 4, Article 28). Thus, in order to fund the infrastructure and
development projects that the central government encouraged, local
governments have used state-owned resources and assets, especially
land, as collateral to set up local government financing vehicles that
meet basic asset and cash flow lending requirements and then borrowed
from the state banks through the local government financing vehicles.
---------------------------------------------------------------------------
By directing the banks to extend so much cheap credit to
local government financing vehicles and SOEs for state sector
projects unlikely to generate revenue in the short term, the
central government has encouraged SOEs and local governments to
hold too much debt, increasing the likelihood that the banks
will require another government bailout or restructuring due to
an accumulation of nonperforming loans and a sudden drop in
profits.\52\ Despite the high ratio of outstanding bad loans to
capital, however, the stability of the banks may be relatively
assured in the near term because the banks are undergirded by
the central government and the central bank. Dr. Walter
describes the backstops in the financial system as a shell game
with three shells: the government itself, the banks, and the
SOEs. ``You can move these bad loans anywhere you want,'' he
says, to ensure that the banks remain solvent.\53\ But the
central government's effort to rein in risky bank loans has
fueled a boom in unofficial credit that presents more complex
problems for authorities. As the challenges of obtaining bank
credit have mounted, local governments and private sector
businesses have increasingly relied on alternative, less
regulated, and less transparent financing channels to fund
investment projects.\54\ This explosion of unofficial credit
complicates existing challenges for the government's efforts to
rebalance the economy and maintain financial stability.
Strains on Rural Credit Cooperatives_The Big State Banks of the
Countryside
Rural credit cooperatives are locality-based credit
institutions important to banking and credit in rural China.
Although they account for only 10 percent of total deposits and
loans nationwide, 80 percent of rural deposits and loans are
made using rural credit cooperatives. They are the primary
providers of credit to rural households and the primary holders
of rural household savings.\55\ As of 2010, the rural credit
cooperative system included 2,646 rural credit cooperative
county unions, 223 rural cooperative banks, and 85 rural
commercial banks.\56\ Rural credit cooperatives have
historically been ``first and foremost accountable to the
party, rather than to depositors or shareholders,'' and they
are frequently urged to support local government enterprises
and projects.\57\ Since 2003, the rural credit cooperatives
have been managed by provincial credit unions that report to
provincial governments, but local party leaders also continue
to influence loan allocations and decisions.\58\
The financial performance and asset quality of rural credit
cooperatives vary, but Dr. Ong notes in written testimony to
the Commission that rural credit cooperatives are a
longstanding weak link in China's fiscal system, because they
are perpetually ``saddled with mountains of bad loans.'' \59\
In 2007, the PBOC provided RMB 168 billion in debt-for-bonds
swaps and RMB 830 million in earmarked loans to assist rural
credit cooperatives in disposing of bad assets and writing off
historical losses.\60\ The stability of rural credit
cooperatives improved after their bailout but, like the state-
owned banks, they heavily supported the 2008-2009 stimulus
programs and are likely experiencing deteriorating asset
values.
Although the central government is not technically under
any formal obligation to ensure the stability of the rural
credit cooperatives, much like the big, state commercial banks,
they are treated as if they are too big to fail. Most likely
this is due to the risk of social unrest in the event of a
rural financial collapse.\61\ Because rural credit cooperatives
are locality specific, the collapse of a rural credit
cooperative would be less likely to cause cross-regional
economic panic and bank runs than would the collapse of one of
the big state banks, but rumors of a collapse in one region
could potentially incite panic and runs in another.\62\
Shadow Banking
The ``shadow banking system'' can broadly be defined as
lending that falls outside of the official banking system.*
\63\ It can involve both traditional and nontraditional
institutions and is best understood not in terms of the
institutions engaged in the system but in terms of the
activities that they undertake.\64\ It encompasses a ``broad
range of bank-like activities (often using uninsured, short-
term funding) that are lightly scrutinized and only sometimes
backed by private sector sources of liquidity.'' \65\ Since
shadow banking activity occurs outside of formal banking
channels, it does not appear on bank balance sheets and is far
less transparent than official lending activity. Chinese shadow
banking products include entrusted loans (loans made by a third
party to a borrower where a bank or other financial institution
serves as the intermediary), investment trusts, wealth
management products, credit guarantees, trusts, money market
products, and various types of microloans.\66\
---------------------------------------------------------------------------
* The term ``shadow banking'' refers to ``the whole alphabet soup
of levered up non-bank investment conduits, vehicles and structures''
that are either unregulated or less regulated than conventional bank
loans. In the prefinancial crisis U.S. context, this meant money market
funds, asset-backed securities, leveraged derivative products, and
other nonbank assets in the capital market that featured prominently in
the U.S.'s subprime mortgage crisis. Paul A. McCulley, ``Global Central
Bank Focus: Teton Reflections'' (PIMCO, September 2007).
---------------------------------------------------------------------------
Since shadow banking is dominated by lending to higher-risk
borrowers, it is frequently characterized by high fees and high
interest rates.\67\ Loans are often arranged by middlemen who
are paid a fee, and borrowers sometimes pay interest as high as
70 percent or more per year.\68\ Such high rates are charged
despite the fact that the legal maximum interest rate is
currently 23 percent and by law cannot exceed four times the
benchmark lending rate, currently 6 percent for one-year
loans.\69\ Commission witness Regina Abrami, Wharton's director
of the Global Program at the Lauder Institute of International
Studies and Management, points out that some non-bank-based
financing in China, in the form of private money houses,
pawnshops, and revolving credit associations, dates back
centuries. This financing has long served much as it does today
``to aid the economic transactions of firms and individuals who
might not otherwise be able to obtain funding or resolve short-
term liquidity crises.'' \70\ Chinese demand for shadow banking
is largely driven by the growth of China's private sector, a
sector with limited access to official bank credit; and the
Chinese government's tolerance of shadow banking in recent
years has been tied to the reality that the private sector is
the increasingly dominant source of the nation's employment. In
1980, the state sector accounted for 76.2 percent of urban
employment. But by 2012, official Chinese sources attributed 80
percent of urban employment and at least 60 percent of China's
GDP to the private sector.\71\
According to written testimony prepared for the Commission
by Bloomberg Businessweek's Sheridan Prasso, 97 percent of
China's 42 million privately owned SMEs are unable to obtain
officially sanctioned loans from the big state banks.\72\
According to the official Xinhua news agency, 19 percent of all
bank lending went to small businesses in 2011, and KPMG
estimates that the size of SME lending in the banking sector
may now account for as much as 25 percent of total bank
lending, but ``these figures are distorted by the lack of
differentiation between state-owned and privately owned SMEs.''
\73\ Certainly the majority of China's private sector is
comprised of SMEs, many of them unregistered businesses, but
there are no data on the percentage of SMEs with significant
ties to the state.\74\ Chinese businesses ``fall into a
bewildering variety of legal categories and their respective
contributions to GDP are not reported in official statistics,''
but China's National Bureau of Statistics estimates that
enterprises not majority owned by the state now account for at
least two-thirds of the country's industrial output.\75\
Figure 3, below, shows Chinese state-owned enterprises'
declining share of industrial output. Figure 4 depicts the
growing market share of private industrial enterprises with
revenues exceeding RMB 5 million.
Figure 3: Chinese State-owned Enterprises' Percent Share of
Industrial Assets, Sales and Profits, 2000-2009
Source: ``Let a Hundred Flowers Bloom,'' Economist, March 10, 2011.
http://www.-economist.-com/node/18330120, sourced from hedge fund
Keywise Capital Finance.
Figure 4: Growth of Industrial Enterprises with Revenues Exceeding
RMB 5 Million, 2000-2009
Source: Economist, ``Let a Hundred Flowers Bloom,'' March 10, 2011.
http://www.-economist.-com/node/18330120, sourced from New York City-
based research firm China Macro Finance.
Although China's banks continue to control a significant
percentage of the country's capital, their percentage of
overall lending is shrinking as the private sector grows.
Commercial banks accounted for 52 percent of the country's
total financing in 2012, down from roughly 90 percent a decade
ago.\76,77\ Shadow banking is filling in this gap. As a result
of their limited access to official sources of credit, private
sector businesses seek capital from the unofficial alternative
channels in the shadow banking system. ``Helping them along on
the supply side,'' Dr. Abrami noted, ``are hundreds of millions
of Chinese savers, profitable private firms, and state-owned
enterprises eager to see better returns on their earnings than
is possible through standard deposits within the formal banking
system'' or investment in the markets.\78\
Successfully channeling credit to China's productive
private sector is a necessary precondition for economic
rebalancing and among the biggest financial challenges facing
China's new leadership.\79\ Since the government has undertaken
efforts to rein in the risky bank lending that proliferated
with the 2008 economic stimulus, it has permitted a boom in the
shadow banking system to help maintain the country's
macroeconomic growth.\80\ In addition, Chinese regulators have
regarded shadow banking as ``a byproduct of their attempts to
unleash more market forces in the allocation of capital in
China,'' a useful ``experiment in liberalized interest rates''
and ``an incubator for risk-based capital allocation and
financial innovation.'' \81,82\ In the meantime, the ever-
tightening restrictions on access to official sources of credit
have shifted more and more borrowers to shadow alternatives.
Shadow banking meets important market demands, ensuring that
the private sector businesses generating so many of China's
jobs are able to access credit when they need it.\83\ The
growing pool, says Dr. Abrami, has also now ``moved beyond
small enterprises to include larger firms, local governments .
. . and businesses within politically disfavored sectors, such
as property development and mining,'' effectively circumventing
the government's efforts to rein in lending to overdeveloped
sectors.\84\
No one knows with certainty the size of China's shadow
banking system but, according to Chinese Central Bank estimates
and much private sector analysis, it is valued at RMB 2
trillion to 4 trillion ($325 billion to $630 billion), or
approximately 7 percent of total lending, four times its
estimated size in 2008.\85,86\ The China Banking Regulatory
Commission has produced a higher estimate of RMB 7.6 trillion
($1.2 trillion) for 2012, which is equal to 14.6 percent of
China's 2012 GDP.\87\ Total off-balance-sheet banking activity
in China, including ``credits to property developers, local-
government entities and small-and-medium size enterprises
(SMEs), individuals and bridge-loan borrowers,'' has been
estimated as high as RMB 17 trillion as of the end of 2012, or
roughly one-third of GDP.\88\ Even by this largest and most
expansive estimate, the shadow banking system is still smaller
than China's commercial banking industry, which had an
estimated $21 trillion in assets as of September 2012.\89,90\
And by comparison with the shadow banking systems of the West,
China's shadow banking is also relatively small. According to
the Financial Stability Board, shadow banking had $23 trillion
in assets in the United States and $22 trillion in assets in
the European Union in 2012. Nevertheless, the recent
exponential growth of the Chinese shadow banking sector,
combined with the continued growth and increasing economic
importance of the private sector relative to the state sector,
is driving a ``reduction in the use of the official banking
system to perform basic functions of finance.'' \91\ In some
parts of China, informal lending now exceeds official bank
lending.\92\
------------------------------------------------------------------------
------------------------------------------------------------------------
Chinese Shadow Banking Terminology
Bank Trust Products
Bank trust products are packaged by trusts and sold by banks,
frequently resulting in a lack of transparency as to whether the bank or
the trust is responsible for their performance.\93\
Entrusted Loans
Entrusted loans are products that allow banks to serve as middlemen by
identifying high-net-worth individuals who can provide corporate loans.
According to Bloomberg News, entrusted loans last year accounted for
nearly 8 percent of the RMB 14.27 trillion ($2.3 trillion) raised in
private placements--loans and other funding sources, such as returns on
stocks and bonds--compared with 0.9 percent in 2002.\94,95\
Passageway Deals
In passageway deals, trusts and brokerages cooperate with banks to act
as passive reservoirs for loans that banks originate but cannot keep on
their own balance sheets without exceeding lending quotas or
transgressing capital requirements or loan-to-deposit ratios. Investors
who have purchased wealth manage-
------------------------------------------------------------------------
------------------------------------------------------------------------
------------------------------------------------------------------------
Chinese Shadow Banking Terminology--Continued
ment products from the banks often bear the risk if borrowers default on
the loans that the trust companies and brokerages have purchased from
the banks.\96\ Industry executives say at least 50 percent of trust
company assets and 80 percent of brokerages' entrusted funds are
related to this so-called ``passageway business.'' \97\
Peer-to-Peer Lending
Peer-to-peer lending is a form of microcredit, and the companies that
facilitate it online match borrowers with lenders able to offer small,
short-term loans. The peer-to-peer lending market is worth approximately
$3.2 billion and is comprised of approximately 2,000 online sites.\98\
Peer-to-peer loans can be as small as RMB 50. One of the better known
Chinese peer-to-peer lending companies, Creditease, reports that its
average loan is RMB 50,000 ($8,200), ``too small for banks but
attractive to online micro-financiers.'' \99\
Trust Companies
There are 64 Chinese trust companies today, with assets valued
collectively at approximately $1.2 trillion.\100\ Trust companies have
surpassed the insurance industry in China in terms of the value of their
assets and are now second only to the banking industry.\101\ Bank of
America Merrill Lynch estimates that trust companies account for 8.9
percent of all bank loans.\102\
Wealth Management Products
Wealth management products are the fastest-growing investment vehicle
in China. Banks funnel money deposited by savers into these riskier
investments that are mostly held off of their balance sheets and sell
them to support their credit growth, since wealth management products
allow them to circumvent the China Banking Regulatory Commission's caps
on interest rates for bank loans. These are highly nontransparent
products because of a lack of disclosure requirements.\103\ Total
outstanding issuance of wealth management products was approximately RMB
6.7 trillion ($1.1 trillion) in the third quarter of 2012, an increase
of 47 percent from the end of 2011.\104\ Bank of America Merrill Lynch
estimates that wealth management products comprise 8 percent of all bank
loans.\105\ Fitch Ratings Agency recently estimated that these products
now account for approximately 16 percent of all commercial bank
deposits.\106\ Wealth management products generally offer 4 to 5 percent
yields, roughly 1 percent higher than the ceiling on deposit rates. The
China Banking Regulatory Commission was initially supportive of the
growth of wealth management products offered by banks, but amid recent
concerns over defaults, regulators have cracked down on the
practice.\107\
------------------------------------------------------------------------
Shadow Banking Risks
According to recent analysis by the Federal Reserve Bank of
Dallas, ``Shadow banks are [now] at the center of our global
market-based financial intermediation system, conducting
maturity, liquidity, and credit transformation without explicit
public sector credit guarantees or liquidity access.'' \108\
The explosion of new financing vehicles presents risks that
investors may not understand and that appear to outstrip
government regulatory capacities. In the aftermath of the 2008
financial crisis, there has been a push among regulators, both
in the United States and abroad, to increase scrutiny of these
financial intermediaries in order to reduce risks in the global
financial system as well as in domestic ones.
In December 2012, the IMF released an assessment
identifying shadow banking as one of the key risks to China's
continued financial stability.\109\ According to Ms. Prasso,
``The primary risk to the [Chinese] government lies in its
potential inability to intervene if a large number of
underground loans suddenly go bad in a crisis; there is no
centralized place to put the money, as in a bank bailout.''
\110\ Dr. Abrami also notes that the Chinese government may not
be able to sufficiently regulate the risks posed by the rapid
proliferation of private lending activities.\111\
A particular cause for worry is the extent to which
traditional Chinese banks may be exposed to the risks of the
shadow banking system. Fitch Ratings Agency estimates that
about 80 percent of new shadow banking credit is tied to the
big commercial banks and that an even bigger percentage of
outstanding shadow banking loans is linked to these banks.\112\
The banks are moving undesirable assets into the shadow banking
system ``on an unprecedented scale, reinforcing suspicions that
bank balance sheets reflect only a fraction of the actual
credit risk lurking in the financial system.'' \113\ Trust
companies and brokerages are a vital source of credit for banks
seeking to ``arrange off-balance-sheet refinancing for maturing
loans that risky borrowers cannot repay from their internal
cash flow.'' \114\ As the Financial Times' Kate Mackenzie
explains:
The elephant in the room is that the shadow
institutions are the co-dependent evil twins to the
commercial banks . . . banks are reliant on the shadow
institutions to supply their liquidity, and shadow
institutions get a lot of their capital from the banks.
. . . Not only does the shadow market fund the banks,
but banks fund the shadow market: banks are the
ultimate source of many `non-standard' financial
products. . . . The whole market is running on the rate
arbitrage between official channels, which lend at 6.5-
9.5 percent, and gray channels, which lend at 12-60
percent.\115\
Whenever the central government eases monetary policy, the
big banks tend to lend excessively, but when it tightens
monetary policy, the shadow banking system steps into the gaps.
With the banks so closely tied to the shadow banking system, it
appears that tighter official lending rules not only fuel the
growth of unofficial lending but also specifically encourage
the banks to engage in more risky, less transparent
lending.\116\ Banks are increasingly pressing customers to
shift money from the older, regulated parts of their operations
to newer, off-the-books products. ``The key question is no
longer how much risk banks are carrying,'' but how many risky
loans have been shifted to lightly regulated, shadow banking
products offered by the banks and to ``lightly regulated shadow
banking institutions--mainly trust companies, brokerages and
insurance companies.'' \117\
Figure 5, below, illustrates one means by which banks
create and issue off-balance sheet loans.
Figure 5: Example of Off-Balance Sheet Lending by Chinese Banks
Source: The New York Times, ``Questionable Lending in China,'' July
1, 2013. http://www.-ny-times . com / interactive / 2013 / 07 / 02 /
business / Questionable-Lending-in-China.html ? ref = global. As
noted in The New York Times article, this is but one example of how shad
ow banking might work.
China's leadership is turning a sharper eye toward the
risks in the shadow banking system.\118\ Regulators have, for
instance, begun issuing prohibitions against certain types of
lending.\119\ In December 2012, the Ministry of Finance, the
National Development Reform Commission, the People's Bank of
China, and the China Banking Regulatory Commission issued a
communique on curbing illegal financing by local governments,
banning local government borrowing from individuals or
nonfinancial institutions such as trust companies and fund
management companies.\120\ In June 2013, PBOC dramatically
tightened credit in the interbank market, where banks have been
lending money to each other and to large shadow financiers to
fund higher-yield offerings. Despite signs of a liquidity
crunch, the central bank delayed injecting more money into the
markets, insisting that ``overall bank liquidity conditions are
at a reasonable level'' and that banks should ``prudently
manage liquidity risks that have resulted from rapid credit
expansion.'' \121\ China's official Xinhua news agency said on
June 23 that the cash crunch was engineered to curb risky bank
funding of shadow banking activities.\122\
On April 26, the Chinese government announced that more
than 1,400 people had been sentenced to prison terms of at
least five years for illegal shadow banking activities. A total
of 4,170 people have reportedly been convicted of violating
shadow banking rules since 2011.\123\ People charged in the
most recent crackdown were convicted of violations such as
illegal fundraising, public advertising to find lenders, and
promising excessively high rates of return.* \124\ Legal
experts complain, however, that the central government has not
sufficiently clarified what is and is not legal for lenders and
borrowers. They argue that many of those netted in crackdowns
and sweeps are engaged in practices that have not been
explicitly prohibited.\125,126\ Another problem in cracking
down on shadow banking in the absence of increased access to
official lines of credit is that it threatens to starve China's
entrepreneurial companies of capital, which in turn may hinder
China's indigenous innovation.\127\
---------------------------------------------------------------------------
* China's Supreme Court website defines ``illegal fundraising'' as
applying to individuals who receive more than RMB 200,000 ($32,000) of
informal loans or cause losses to lenders of RMB 100,000 ($16,000) or
more. ``Enterprises can face charges if they receive RMB 1 million
($160,000) or cause losses of RMB 2.5 million ($400,000).'' Joe
McDonald, ``China jails more than 1,400 in lending crackdown,''
Associated Press, April 26, 2013.
Market Conditions and Access Issues for Banking, Investment, Insurance,
---------------------------------------------------------------------------
and Other Services Firms
Expanding access to traditional bank lending for China's 42
million SMEs would be a key way for Beijing to allow the
private sector to thrive without compromising the government's
regulatory powers. U.S. financial services firms say China
should provide them with greater market access and operating
capacity so that they can help to develop the Chinese financial
sector. They note that, in contrast with China's bank-dominated
financial system, in the United States, more credit is provided
by financial markets and nonbank lenders than by banks, and
they argue that they offer knowledge, experience, and products
that China needs.\128\ Though China has taken some steps to
expand foreign firms' access to its financial markets since
joining the World Trade Organization (WTO) in 2001, this access
remains quite limited (see Chinese Rationales for Market
Barriers later in this section).
China's economy has long been heavy on manufacturing and
light on services, but the services sector is growing.
Manufacturing accounted for 45.3 percent of China's GDP in
2012, while the services sector (transport, wholesaling,
retailing, hotels, tourism, financial services, real estate,
scientific research, and other services) accounted for 44.6
percent, according to official statistics.\129\ Strengthening
this sector is a key goal of China's 12th Five-Year Plan for
Economic and Social Development, as its expansion promises the
creation of new jobs, increased domestic consumption and
decreased dependence on exports and state investment projects
for economic growth--all vital to the economic rebalancing
needed to reduce the U.S.-China bilateral trade deficit.\130\
Unfortunately, the financial services subsector has not been
growing as quickly as services overall, despite the fact that
the development of this subsector is particularly crucial to
China's achievement of its rebalancing goals. As Mr. Dearie
told the Commission, ``Capital is the lifeblood of any
economy's strength and well-being, enabling the investment,
research, and risk-taking that fuels competition, innovation,
productivity, and prosperity.'' \131\ An obvious way to
increase access to capital is to spur development of the
financial services sector in China. Fundamentally, the
financial services sector struggles to thrive because of the
extent of government intervention in the overall financial
system. While the explosion of the shadow banking sector and
the government's tolerance of it indicate the leadership's
recognition of the need for financial liberalization, the
government has been slow to embrace financial liberalization.
This foot dragging continues even as the risks attendant in
shadow banking underscore the importance of developing more
comprehensive and well-regulated financial services than the
informal shadow banking trend offers. The shortage of financial
services inhibits the very consumption that China's leaders
have committed to cultivate. While domestic consumption per
capita continues to grow, it has actually fallen as a
percentage of GDP from more than 60 percent to less than 50
percent between 2000 and 2013, and more than half of the wealth
in Chinese households today is still held in the form of low
interest rate savings.\132\
Empowering the Chinese consumer requires the broad
availability of financial products and services, including
personal loans, credit cards, mortgages, pensions, insurance
products and services, and retirement security products. This
would in turn persuade Chinese citizens to reduce their
precautionary savings.\133\ U.S. financial services firms have
long argued that if China would open its market to more
investment, they could grow their own business. China has taken
some steps to further open its financial services market in
recent years. Foreign direct investment in financial services
increased 122 percent between 2007 and 2010, but foreign access
to China's financial markets more broadly remains heavily
restricted, and this apparent high growth rate belies the fact
that investment grew from a very small market share.\134\
Foreign ownership in the Chinese banking system, for example,
currently amounts to less than 2 percent.\135\ And, according
to Steve Simchak, director of International Affairs at the
American Insurance Association, foreign property-casualty
insurers in China currently hold only a 1.2 percent market
share as a result of significant market entry barriers and a
lack of national treatment.* \136\
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* National treatment is a principle of international law by which
states guarantee that they will not favor their own citizens or
businesses with treatment better than what they afford to those of
their trading partners.
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U.S. financial services companies complain that even as the
United States has taken steps to allow increased Chinese access
to its financial services market, China is not reciprocating.
The Wall Street Journal reported that China's state-run Citic
Securities is applying for a license with U.S. regulators,
making it the latest Chinese firm to expand into the United
States as the Chinese government continues to encourage its
financial services companies to invest more of the nation's
foreign exchange reserves in foreign markets. Yet within China,
foreign banking, securities, and insurance affiliates all
continue to be subject to ownership restrictions and regulatory
approval processes for their investments that are far more
stringent than those that apply to domestic competitors.
China's minimum capital requirements for foreign banks seeking
to operate in the Chinese market exceed international norms,
and foreign banks also cannot open new branches without
permission from regulators and face cumbersome and lengthy
approval processes.\137\ Foreign-owned securities and asset
management firms are limited to joint ventures in which foreign
ownership is capped at 49 percent, while foreign life insurance
companies remain limited to 50 percent ownership in joint
ventures and to 25 percent equity ownership of existing
domestic companies; and, until a 2012 WTO dispute settlement
panel ruling, market access for foreign electronic payment
providers was virtually nonexistent.\138\
In his testimony to the Commission, Professor Saulski noted
that studies by the Organization for Economic Cooperation and
Development and the World Bank ranked China as ``one of the
most restrictive markets for financial services among the
G20.'' China is also far more restrictive than its fellow major
developing economies: Brazil, Russia, and India.\139\ Professor
Saulski further explained that ``the current lack of
significant competition in China's financial sector hinders
efficiency, limits investor choice, and restricts access to
capital by non-state-owned firms. Furthermore, the lack of
competition in China's financial markets facilitates
destructive rent seeking behavior by special interest groups
and well-connected individuals. In its most pernicious form,
this creates a perfect environment for fraud, insider dealing,
and corruption.'' \140\
Chinese Rationales for Market Barriers: The General Agreement on Trade
in Services (GATS) and the Global Economic Crisis
Though China's restrictions on market access to the
financial services sector are significant, they are compatible
with the country's 2001 WTO accession agreement, which was
largely negotiated by the United States acting on behalf of
other WTO members. Under the WTO's General Agreement on Trade
in Services, Most Favored Nation (MFN) status and national
treatment apply only as specified in a member country's
schedule and MFN exemption list.* \141\ WTO members are
explicitly allowed to provide non-MFN treatment if they record
the exemptions in their WTO schedule of services commitments,
though these exceptions are subject to negotiation in future
multilateral trade talks. Members also are not obligated to
provide national treatment except for the service categories
that they choose and only to the extent recorded in their
schedule of WTO services commitments. Agreements to gradually
eliminate or reduce limitations to market access are also
voluntary, ``applying only to those service categories included
in a Member's schedule and only to the extent specified.''
\142\ Because many of the obligations under GATS are voluntary,
most WTO members, including China, were selective about the
service sector categories
for which they undertook obligations in their accession
agreements.\143\
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* Most Favored Nation treatment is a means of establishing equality
of trading opportunity between states by ensuring that all nations
accorded MFN status are treated equally by any given trading partner.
An importing country cannot discriminate against the goods from one MFN
country in favor of another MFN country's goods. If an importing
country grants any type of concession to one MFN trading partner, this
concession must also be given to all other countries with MFN status.
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At the ten-year review of China's WTO accession agreement
in 2011, the United States criticized China's lack of progress
in fully implementing its financial services obligations,
honing in on continued restrictions on foreign ownership of
Chinese banks and insurance companies. The Office of the U.S.
Trade Representative (USTR) noted in its 2012 report to
Congress on China's WTO compliance problems that ``China has
continued to maintain or erect restrictive or cumbersome terms
of entry in some sectors.'' USTR also underscored problems with
``informal bans on new entry, high capital requirements,
branching restrictions or restrictions taking away previously
acquired market access rights.'' \144\ The Chinese claimed that
their refusals to fully open the financial services sector were
justified by the 2008 financial crisis, which cast developed
nations' financial systems in an unfavorable light. As a senior
official at the Shanghai Stock Exchange reportedly put it in
2009, ``The master has been proven to be a fool.'' \145\ Mr.
Dearie noted in his testimony that a major increase in negative
Chinese perceptions of the U.S. financial system due to the
global economic crisis damaged the ability of U.S. financial
services firms to access the Chinese market and of USTR to
negotiate greater access.\146\
In June 2010, China proposed new WTO financial services
discussions aimed at examining ``the gains and pains'' of
financial liberalization and financial regulatory practices
suited to developing countries. China reportedly noted:
While many see liberalization of trade in financial
services as an essential contributing factor towards
the development of the sector, others regard excessive
and premature liberalization of the financial sector as
a key ingredient for financial instability. . . . This
is a particularly relevant subject in the post-crisis
era, as many countries are now concerned about how to
develop their financial sector so that it generates
real economic growth rather than asset bubbles. . . .
There is increasing evidence that the developed Members
may also have taken excessive liberalization
commitments. Before the financial crisis, deregulation
was the main trend in the domestic financial market of
the developed countries, and in the international
arena, the developed countries pushed for more
liberalization commitments to gain greater financial
deregulation in the markets of their trade partners.
The financial crisis has brought a sharp turn in the
way we think about financial deregulation, and now the
most popular word for the financial regulators is
`reregulation.' \147\
China also warned that foreign services firms would
dominate the most profitable sectors of the Chinese market,
impeding the development and success of domestic firms. In
addition, China worried that foreign firms might act as
conduits for household savings to be funneled out of the
country rather than invested domestically and that the
increased linkages with the global financial system could leave
China more susceptible to volatilities in the global
market.\148\
China's Financial Sector--Foreign Investors Experience Problems with
Governance, Transparency, and Accountability
Even if foreign service firms were given access to
household savings in China, weak corporate governance,
regulatory oversight, and accounting practices in China create
problems for potential foreign investors. Investor confidence
in China's securities markets and in Chinese companies trading
on U.S. and other foreign exchanges is important to the Chinese
government's economic rebalancing efforts. Selling shares of
Chinese companies to foreign investors has become an
increasingly significant means of raising capital. However,
China's traditional banking system and its publicly traded
corporations are hobbled by poor audit quality and unreliable
financial statements. Investor confidence depends on
transparent and reliable accounting and audit regimes--to which
the Chinese government has shown resistance. Improvements in
the governance of China's companies and its capital markets are
critical to protecting American shareholders and American
investments in China.
China's Corporate Governance Creates Challenges for Investors and
Regulators
Demand for credit has led Chinese companies to seek capital
overseas even as its shadow banking system has expanded. In the
late 1990s, Chinese companies began raising capital on major
international stock exchanges. This trend has been driven by
large Chinese companies, many state owned, that have sought to
broaden their shareholder base, increase the liquidity of their
shares, and enhance the visibility of their brand names. In
part, it has also been driven by small- and medium-sized
private Chinese companies seeking alternative capital options
beyond the state-controlled banks that dominate China's
financial system, and the limited domestic exchanges.
U.S. stock markets are among the most popular alternate
global exchange destinations for Chinese firms. According to
Commission witness Paul Gillis, professor at Peking University
and Standing Advisory Group member of the Public Company
Accounting Oversight Board (a quasi-public entity established
by the Sarbanes-Oxley Act that polices auditors and reports to
the U.S. Securities and Exchange Commission (SEC)), there are
more than 200 Chinese companies that have offered shares of
stock on the New York Stock Exchange and NASDAQ in recent
years, and hundreds more have entered U.S. over-the-counter
markets.\149\ However, many of the Chinese companies listing in
the United States have proved to be poor investments.
Initially, U.S. investors purchased stock in U.S.-listed
Chinese companies in hopes of profiting from China's rapid
growth rate. However, investors in U.S.-listed Chinese
companies have increasingly found that insufficient corporate
governance standards make these companies high-risk
investments. Many have been implicated in frauds and accounting
scandals, and U.S. regulators have deregistered about 50
Chinese companies in the past two years following fraud
probes.\150\ The stigma attached to U.S.-listed Chinese
companies as a result of this regulatory scrutiny has lowered
returns for nearly all of them. The 82 companies in the
Bloomberg Chinese Reverse Mergers Index lost 52 percent of
their market value between June 2011 and July 2012.\151\ U.S.-
listed Chinese companies are ``deserting U.S. stock markets in
record numbers as regulatory scrutiny mounts and the advantages
of a U.S. listing slip away.'' \152\ Six U.S.-listed Chinese
companies announced plans to go private through buyouts in
2010, but by 2012, 27 Chinese companies had announced they
would go private. In addition, approximately 50 mostly smaller
U.S.-listed Chinese companies deregistered with the SEC, ending
their requirements for public disclosures, in 2012.\153\ In
addition, far fewer Chinese companies are listing on U.S.
exchanges. Only three Chinese companies successfully went
public on U.S exchanges in 2012, down from 41 in 2003.\154\
Two types of Chinese companies in particular have sought
access to U.S. capital markets: smaller enterprises with
limited ability to use Chinese capital markets, and some of the
largest state-owned enterprises in industries such as petroleum
and telecommunications.\155\ Larger Chinese state-owned
enterprises have primarily entered the U.S. markets by openly
filing IPOs on the New York Stock Exchange and NASDAQ in the
form of American Depository Receipts (ADRs) or ordinary
shares.* \156\ In 1993, state-owned Sinopec Shanghai
Petrochemical was the first Chinese company to list on a U.S.
exchange by issuing an IPO in the form of ADRs.\157,158\
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* An ADR is a certificate representing one or more shares of a
foreign firm's stock, denominated in U.S. dollars.
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Smaller private Chinese companies have most commonly sought
access to U.S. markets because they lack sufficient domestic
sources for capital and have entered the markets by merging
with existing, registered U.S. shell companies in reverse
mergers. Reverse mergers do not require approval from the China
Securities Regulatory Commission (the Chinese counterpart of
the U.S.'s Public Company Accounting Oversight Board) and
involve much less regulatory scrutiny by the SEC than do IPOs.
A reverse merger involves a private company purchasing a
publicly traded company and shifting its management into that
company. This allows the private company to become publicly
traded without going through the regulatory and financial
disclosure processes associated with an IPO. Most Chinese
reverse mergers are traded on the over-the-counter market until
they satisfy various requirements, such as size and
capitalization level, that qualify them to list on the New York
Stock Exchange or NASDAQ. Between 2000 and 2011, approximately
443 Chinese companies entered U.S. markets via reverse mergers,
but relatively few of these have made it off of the over-the-
counter market and onto the New York Stock Exchange or
NASDAQ.\159\
As of May 2012, there were approximately 112 Chinese
companies traded on the New York Stock Exchange or NASDAQ in
the form of ADRs, 21 traded in the form of ordinary shares, and
79 that listed via reverse merger transactions.\160\ Large
Chinese companies entering U.S. markets via IPOs, including
state-owned enterprises, have accounted for the greatest share
of Chinese companies' market capitalization, but they have been
greatly outnumbered by smaller Chinese companies entering U.S.
markets via reverse mergers. This latter group has also
generated a sizeable portion of Chinese companies' market
capitalization. According to the Public Company Accounting
Oversight Board, between January 2007 and March 2010, 159
Chinese companies entered the U.S. securities markets using
reverse mergers and generated market capitalization of $12.8
billion. In the same period, 56 Chinese companies, including a
number of very large, state-owned enterprises, completed U.S.
IPOs and had an aggregate market capitalization of $27.2
billion.\161\
Chinese Reverse Mergers Skirt Oversight
Chinese reverse merger transactions have attracted the bulk
of the critical attention from U.S. regulators. Companies that
enter the U.S. market via reverse mergers are riskier
investments, because they do not go through the disclosure
processes associated with traditional IPOs and thus offer less
information to investors. In response to increasing complaints
involving foreign reverse mergers, the SEC issued a bulletin in
June 2010 warning investors of the risks of fraud and other
abuses involving reverse merger companies. The SEC also set up
a task force to investigate the foreign company reverse merger
trend and associated investor risks. In November 2011, the SEC
approved new NASDAQ, New York Stock Exchange, and American
Stock Exchange rules that impose more stringent listing
requirements for reverse mergers. Under the new rules, a
reverse merger company cannot apply to list on the New York
Stock Exchange, NASDAQ, or the American Stock Exchange until it
has completed a one-year ``seasoning period'' of trading on the
U.S. over-the-counter market or on another regulated U.S. or
foreign exchange following its reverse merger. It also must
file all required reports with the SEC, including audited
financial statements, and maintain a minimum share price of
$2.00 to $4.00 for at least 30 of 60 trading days immediately
prior to filing its listing application.\162,163\
An ABC News investigation in January 2013 found that since
2010, more than 70 Chinese companies have been removed from or
left NASDAQ and the New York Stock Exchange after reports of
alleged fraud and financial irregularities.\164\ In 2008 and
2009, there were very few U.S. federal securities class actions
filed against companies domiciled in China. In 2010, Chinese
companies were the target of 15 such suits, and by 2011, that
number had risen to 38 suits--accounting for 17 percent of the
224 U.S. federal securities class actions filed in 2011 and
nearly 66 percent of the 60 such suits targeting non-U.S.
companies.\165\ At least 42 of the Chinese companies targeted
by U.S. securities class actions to date were listed on U.S.
stock markets via reverse mergers and have been subjects of SEC
investigations of financial schemes that former SEC Chairman
Mary Schapiro described as ``brazen.'' \166\ According to
analysis by the Harvard Law School Forum on Corporate
Governance and Financial Regulation, ``Over 85 percent of U.S.
securities class actions filed against Chinese issuers from
2008 to mid-2012 have included accounting-related
allegations.'' \167\
In order to be publicly traded on the U.S. capital markets,
companies have to make public certain information about their
business strategies, operations, material risks, and financial
results. The financial statements contained in companies'
annual reports filed with the SEC are required to have an
independent external audit for consistency with U.S. accounting
standards. These standards are the same for all companies
notwithstanding where they are registered. In its 2010 Annual
Report to Congress, the Commission noted that SEC standards for
assessing material risks may benefit from singling out certain
nations for special scrutiny, based on their domestic
accounting standards. For example, there is no reporting
requirement that takes note of the unique and politicized role
that the CCP plays in the selection of Chinese corporate
leadership.
The House Financial Services Committee sent a letter to the
Public Company Accounting Oversight Board and the SEC on
September 9, 2010, complaining of the quality of auditing of
U.S.-listed Chinese companies. The Big Four accounting firms
(PricewaterhouseCoopers, KPMG, Deloitte Touche Tohmatsu, and
Ernst & Young) audit 88 percent of all U.S.-listed Chinese
companies, including a number of the companies named as
defendants in U.S. government-filed law suits.\168\ Public
Company Accounting Oversight Board standing advisory group
member and Commission witness Paul Gillis noted in a recent
report that fraud and accounting issues associated with U.S.-
listed Chinese companies have brought mounting pressure for
these accounting firms to verify that they have conducted their
audits properly.\169\
SEC Cracks Down on Accounting Firms of Chinese Companies
During recent probes, the SEC has sought audit work papers
from the accounting firms, a common request during fraud
investigations. To date, the firms have refused to produce
these documents, arguing that doing so would put them in
violation of Chinese state secrets laws. In China, sharing
accounting information with foreign regulators and removing
audit papers from the country violates state secrets laws.
Chinese authorities also do not permit non-Chinese regulators
to conduct investigations in China.\170\ Chinese law
``prohibits firms from producing audit working papers directly
to any foreign regulator and requires those foreign regulators
to seek such documents through the China regulator,'' according
to Commission testimony by Cynthia Fornelli, executive director
of the Center for Audit Quality.\171\ China has several times
amended its Law on Guarding State Secrets to be more inclusive
of a variety of information, including economic
statistics.\172\ China is also applying its State Secrets Law
to private companies. In the SEC's investigation of Deloitte
Touche Tohmatsu's auditing of China-based Longtop Financial
Technologies, for instance, Deloitte said Chinese regulators
had warned them that turning over working papers to the SEC
could lead to sentences of life imprisonment for the partners
involved and to the banishment of their firm from conducting
further business in China.\173\ In the United States, however,
withholding foreign public accounting paperwork of U.S.-traded
companies violates both the Securities Exchange Act and the
Sarbanes-Oxley Act, which require foreign audit firms to
produce documents concerning U.S.-listed clients at the SEC's
request.\174\
In December 2012, the SEC charged five firms with breaking
U.S. securities laws by refusing to turn over the requested
audit work papers. The defendants in the case are Beijing-based
BDO China Dahua, Ernst & Young Hua Ming, KPMG Huazhen,
Shanghai-based Deloitte Touche Tohmatsu Certified Public
Accountants, and PricewaterhouseCoopers ZhongTian. China-based
affiliates of these accounting firms face the possibility of
losing both their right to practice and their registration with
the Public Company Accounting Oversight Board.
Initially, U.S. audit firms entered the Chinese market as
joint ventures with Chinese partners. The Big Four in most
countries are owned by local partners, operating more like a
franchise than a typical multinational corporation. China has
required the Big Four to convert into limited liability
partnerships as their 20-year joint venture terms began to
expire in late 2012. In May 2012, the Chinese government
announced that by December 31, 2017, the Big Four must evolve
into partnerships in which Chinese-qualified accountants are a
majority of the firm's accountants. The new regulation will cap
the level of foreign-qualified accountants at the firms at 40
percent initially and at 20 percent by the end of 2017. In
addition, the regulation will limit the voting rights of all
partners with foreign qualifications and require that all
senior partners be Chinese citizens. This change will limit
U.S. corporate opportunities to manage audit operations,
further complicating SEC enforcement efforts in China.\175,176\
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Accounting Fraud Impacts U.S. Companies Operating in China
Fraud and accounting problems associated with China are not limited to
U.S.-listed Chinese companies. U.S. companies have directly invested $54
billion in Chinese businesses, factories, and property, most of it in
the past decade, according to the Department of Commerce. U.S.
corporations' China operations are facing increasing problems. For
example, on January 18, Caterpillar disclosed ``deliberate, multi-year,
coordinated accounting misconduct'' at a unit of ERA Mining Machinery
Ltd., a company it paid $654 million to acquire in June 2012.
Caterpillar has disclosed inventory discrepancies, inflated profits, and
improperly recorded costs and revenue at the ERA Siwei unit, located in
Zhengzhou, China. The Caterpillar experience and the growing catalog of
smaller instances of deception and abuse involving U.S. companies' China
corporations indicate that U.S. companies' Chinese investments
experience unique accounting and governance challenges. The financial
and legal advisors for Caterpillar and ERA included Citigroup,
Freshfields Bruckhaus Derringer LLP, Blackstone, and DLA Piper. It
appears that they did not detect the fraud prior to the deal
closing.\177\
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Risk Management and Bilateral Cooperation
All accounting firms that audit U.S.-traded public
companies and their employees must register with the Public
Company Accounting Oversight Board. The Public Company
Accounting Oversight Board sets auditing standards and rules
for U.S.-listed companies and is charged with inspecting and
regularly reviewing the audits of all public accounting firms
that audit U.S.-listed companies, including those firms that
audit foreign-domiciled, U.S.-listed companies and are
themselves domiciled outside of the United States.\178\
According to Ms. Fornelli, as of June 2011 there were 54
Chinese mainland auditing firms and 55 Hong Kong firms
registered with the Public Company Accounting Oversight Board,
and the board had performed more than 200 inspections of non-
U.S.-domiciled accounting firms in over 35 jurisdictions,
including Brazil, India, Japan, and Russia.\179,180\
Recognizing a need to improve U.S. financial regulators'
ability to gauge the financial health of companies domiciled in
other jurisdictions, Congress empowered the Public Company
Accounting Oversight Board to negotiate agreements for
reciprocal inspections with audit regulators outside the United
States as well as the confidential exchange of information with
other regulators. This was part of the Dodd-Frank Wall Street
Reform and Consumer Protection Act of 2010. Such cooperation
between the board and foreign auditing oversight bodies was
intended to encourage jurisdictions to better harmonize
auditing standards and requirements. The goal was to eliminate
such conflicts as the SEC's requests for documents that U.S.
accounting firms cannot produce under Chinese law but must
produce under U.S. law.\181\ Ms. Fornelli testified that the
Public Company Accounting Oversight Board now has cooperation
agreements with 16 nations and that after the 2010 Strategic
and Economic Dialogue, the United States and China announced
their intent to negotiate such an agreement on the sharing of
confidential information for regulatory purposes.\182\ However,
the Public Company Accounting Oversight Board and the China
Securities Regulatory Commission have yet to achieve that goal.
The inability of the Public Company Accounting Oversight
Board to inspect in China creates a gap in investor protection.
This lack of an information-sharing agreement with China does
not just limit U.S. regulators' ability to ensure proper
conduct at the Big Four accounting firms. It also limits their
ability to ensure proper conduct at the Chinese-domiciled
accounting firms that audit or play a substantial role in
auditing U.S.-listed Chinese companies and the Chinese
operations of U.S. companies. Though U.S. securities law
requires overseas auditing firms that audit U.S.-listed
companies to undergo inspection by the Public Company
Accounting Oversight Board to ensure that they are following
U.S. standards, China wants the United States to allow the
China Securities Regulatory Commission and the Chinese Ministry
of Finance to conduct and control all investigations of
accounting firms in China, via an audit oversight agreement
similar to the one it struck with the European Union. According
to a statement by Mr. Gillis:
In a 2009 letter commenting on the PCAOB's [Public
Company Accounting Oversight Board] proposed delay in
the deadline for foreign inspections, the CSRC [China
Securities Regulatory Commission] said that any
oversight of Chinese accounting firms should rely
solely on the CSRC. In 2011, the European Union
recognized the equivalence of the audit oversight
systems in 10 third countries, including China. The
third countries and EU [European Union] member states
can now mutually rely on each other's inspections of
audits. Chinese regulators want the same treatment from
the United States, but U.S. laws do not permit the
PCAOB to rely on foreign regulators.\183\
Chinese regulators have been reluctant to offer joint
inspections, as they view such access as a breach of national
sovereignty. If they do agree to some form of joint inspections
between Chinese and U.S. regulators, they will likely insist on
retaining full control over punishment of violations by Chinese
auditors. The Public Company Accounting Oversight Board has
been in negotiations with Chinese regulators since 2010 to try
to work out an agreement and previously set a December 31,
2012, deadline to complete inspections of Chinese accounting
firms. With this deadline passed, failure to reach a
breakthrough in negotiations in the near future ``could lead to
the deregistration of Chinese accounting firms and a mass
delisting of Chinese stocks,'' since U.S.-listed Chinese
companies would no longer have a registered auditor and thus
would have to delist.\184\
On May 24, 2013, the United States and China announced a
deal for limited information-sharing between their regulatory
agencies when there are questions regarding audits of U.S.-
listed Chinese companies. Under the agreement, the U.S. Public
Company Accounting Oversight Board will be permitted access to
audit documents from Chinese accounting firms to use in board
investigations. This deal to facilitate information-sharing
during investigations related to possible sanctions is a step
in the right direction, but it does not resolve the board's
challenges with regard to regular inspections of Chinese
auditing firms, and it is inspections, rather than
investigations, that are the Public Company Accounting
Oversight Board's main function. Under U.S. law, ``firms that
issue reports on public companies are to be inspected at least
every three years'' to ensure that they are in compliance with
U.S. auditing standards, but Chinese law still prohibits
auditors from providing documents to the Public Company
Accounting Oversight Board for such inspections.\185\ At the
July meeting of the Strategic and Economic Dialogue, U.S.
Treasury Secretary Jack Lew announced that Chinese regulators
had agreed to turn over to the SEC certain requested audit work
papers of some Chinese companies listed on U.S. stock
exchanges, a move that will assist the SEC in ongoing
investigations.* However, no further progress has been made
toward achieving more general direct access to documents for
U.S. regulators conducting investigations or inspections. The
May deal also permits China to withhold documents from the
Public Company Accounting Oversight Board ``on grounds of
public interest or essential national interest.'' \186\ As Mr.
Gillis explained in a May 2013 Op-Ed for the Wall Street
Journal, failure to resolve these issues more fully could lead
the SEC and the Public Company Accounting Oversight Board to
ban Chinese accounting firms from auditing U.S.-listed
companies, which could in turn lead to Chinese companies being
delisted from U.S. exchanges. However, this is a ``nuclear
option'' that U.S. regulators are likely reluctant to
pursue.\187,188\
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* Achieving direct access to documents that the Big Four auditing
firms have refused to turn over will aid the SEC in moving forward with
its investigations into certain Chinese companies listed on U.S.
exchanges, including specifically the Deloitte-audited company, Longtop
Financial. As of the drafting of this Report, the SEC's administrative
trial against Chinese affiliates of Deloitte and the other Big Four
audit firms in response to their refusals to turn over audit documents
is ongoing. The presiding judge has reportedly requested a 100-day
extension in the case, pushing the due date for a decision to January
7, 2014.
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Implications for the United States
The rate of China's economic growth over the last 30 years,
and its integration of a fifth of the world's population into
the global economy, has profound implications for economic
growth and job creation in the United States. China is
currently America's third-largest export market and its
fastest-growing export destination. U.S. exports to China have
increased sixfold since 2001, with 48 states experiencing at
least triple-digit growth in their exports to China and 20
states experiencing quadruple-digit growth. That is seven times
the pace at which U.S. exports to the rest of the world have
increased over the same time period.\189\ However, the growth
of U.S. imports from China still far surpasses this growth in
exports to China. (For further discussion of the deficit, see
chap. 1, sec. 1, of this Report.) A more consumption-driven
Chinese economy would mean an expansive growth in Chinese
demand for American products and services. But China lacks the
modern and sophisticated financial sector needed to accomplish
the shift to greater domestic consumption.\190\ Without a more
open and market-oriented financial system, China cannot deliver
on its promised economic rebalancing, and the costs of the
imbalances in the U.S.-China economic relationship will
continue to accrue.
While available measures indicate that China's shadow
banking sector remains smaller than that of the United States,
its size relative to China's formal banking sector continues to
expand, and Beijing's efforts to curb the risky lending in this
sector to date may perversely be fueling it. Expressing
concerns about wealth management products in January 2013, Xiao
Gang, former chairman of the Bank of China and current head of
the Chinese Securities Regulatory Commission, reportedly
characterized the shadow banking sector as ``a potential source
of systemic financial risk,'' whose model is ``fundamentally a
Ponzi scheme.'' \191\ In September, the G20 echoed this view
when it endorsed new global rules for shadow banking issued by
the Financial Stability Board.\192\ While the potential risks
of China's shadow banking sector are not fully understood, to
the extent that it poses systemic risks to China, it is fair to
surmise that it poses risks for international financial
stability more broadly. It is in the interest of the United
States for Beijing to succeed in its efforts to curb risky,
off-balance-sheet lending and establish greater regulatory
control over nonbank financial institutions.
China's opaque policies and practices with regard to
corporate accountability present serious challenges for U.S.
companies and U.S. investors seeking information on the risks
entailed in their transactions.
Conclusions
LThe Chinese economy weathered the first few years of
the global economic downturn by doubling down on its time-
tested strategy of funneling capital into domestic development
projects. But five years on, global demand for Chinese exports
remains too weak to sustain the country's factories, much less
new ones, and the merits of massive infrastructure projects
have more than run their course. The policy decisions that kept
the Chinese economy chugging over the last few years have also
sped it closer to a reckoning that economists have long
forecast would eventually be necessary.\193\ If a rebalancing
of the U.S.-China economic relationship is to be achieved,
China must reform its financial system to support newer,
nonstate sources of economic growth, which will require that
China's banks better service its private sector.
LAs long as China's official, regulated channels of
credit do not possess the flexibility to meet the needs of the
Chinese economy's main job creators, China will be at risk of
depressed economic growth, which in turn may limit the growth
of U.S. exports to China and the prosperity of U.S. investments
in China, slowing economic recovery here at home. The shadow
banking system that Beijing has allowed to step into this
credit gap is insufficiently regulated and, if left unchecked,
will pose an increasingly serious threat to Chinese and global
economic stability.
LThe opacity of Chinese corporate governance and
accountability policies, as well as conflicts with U.S.
securities laws and regulations, hurts investor confidence in
Chinese companies trading on U.S. exchanges. The current
situation threatens U.S. investors with unforeseeable and
unmanageable losses and may lead to a broad delisting of
Chinese companies. China's lack of sophisticated banking,
corporate governance, and auditing policies and practices also
hinders much-needed growth and opportunity for the very U.S.
financial services firms that could help China to restructure
its system if they were allowed greater access to the Chinese
market.
LInsufficient transparency and accountability in
China's financial sector put U.S. firms at risk of violating
laws in both China and the United States; pose unreasonable
hazards for U.S. investors with shares in Chinese companies;
and render some U.S. laws and regulations unenforceable.
Without greater regulatory transparency and assurance of
China's regulatory, oversight, and enforcement capabilities,
Chinese firms also risk curtailment or even revocation of
access to the U.S. market.
ENDNOTES FOR SECTION 3
1. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Sheridan Prasso, March 7, 2013.
2. Dezan Shira & Associates, ``Shadow Banking Poses Hidden Risks
to China's Financial Sector,'' January 2012.
3. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Carl Walter, March 7, 2013.
4. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of Carl Walter, March 7, 2013.
5. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of John Dearie, March 7, 2013.
6. Lucy Hornby and Coco Li, ``China should sell state shares in
mid-tier banks--Minsheng vice chairman,'' Reuters, March 11, 2013.
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7. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Lynette H. Ong, March 7, 2013.
8. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Carl Walter, March 7, 2013.
9. Caijing, ``China's policy banks,'' September 2009.
10. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Carl Walter, March 7, 2013.
11. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of Carl Walter, March 7, 2013.
12. Douglas J. Elliot and Kai Yan, ``The Chinese Financial System:
An Introduction and Overview'' (Washington, DC: The John L. Thornton
China Center at The Brookings Institution, July 2013).
13. Bloomberg, ``China Shadow Bankers Go Online as Peer-to-Peer
Sites Boom,'' July 24, 2012.
14. Leland Miller, ``The Crisis Ahead for China's Policy Banks:
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15. Bloomberg, ``China Shadow Bankers Go Online as Peer-to-Peer
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16. Deposits.org, ``Bank Deposit Rates in China,'' http://
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17. Douglas J. Elliot and Kai Yan, ``The Chinese Financial System:
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18. Yingjie Zhang, ``The Study on the Entry Mechanisms by Chinese
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York at Albany, May 17, 2012).
19. Carl Walter and Fraser Howie, ``Why China Will Never Have a
Wall Street,'' Foreign Policy, February 4, 2013.
20. Carl Walter and Fraser Howie, ``Why China Will Never Have a
Wall Street,'' Foreign Policy, February 4, 2013.
21. Carl Walter and Fraser Howie, ``Why China Will Never Have a
Wall Street,'' Foreign Policy, February 4, 2013.
22. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of Paul Saulski, March 7, 2013.
23. Carl Walter and Fraser Howie, ``Why China Will Never Have a
Wall Street,'' Foreign Policy, February 4, 2013.
24. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of Carl Walter, March 7, 2013.
25. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of Carl Walter, March 7, 2013.
26. Takeshi Jingu, ``China's Growing Corporate Bond Issuance,''
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33. Franklin Allen et al., ``China's Financial System:
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34. KPMG.com, ``Global Debt Sales, China, Third Edition,'' 2013.
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35. Bloomberg, ``China Slowdown Stymies Plan to Curb Shadow
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36. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Carl Walter, March 7, 2013.
37. Economist, ``Asset-management companies in China, lipstick on
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38. KPMG.com, ``Global Debt Sales, China, Third Edition,'' 2013.
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39. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Carl Walter, March 7, 2013.
40. U.S.-China Economic and Security Review Commission, Hearing on
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43. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
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46. Dezan Shira & Associates, ``Shadow Banking Poses Hidden Risks
to China's Financial Sector,'' January 2012.
47. Henry Sanderson and Michael Forsythe, China's Superbank: Debt,
Oil and Influence--How China's Development Bank Is Rewriting the Rules
of Finance (Singapore: Bloomberg Press, John Wiley and Sons, 2013), p.
3.
48. Henry Sanderson and Michael Forsythe, China's Superbank: Debt,
Oil and Influence--How China's Development Bank Is Rewriting the Rules
of Finance (Singapore: Bloomberg Press, John Wiley and Sons, 2013).
49. Wall Street Journal, ``China Further Tightens Rules on Local
Government Borrowing,'' February 20, 2013.
50. KPMG.com, ``Global Debt Sales, China, Third Edition,'' 2013.
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51. Simon Rabinovitch, ``China tells banks to roll over loans,''
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52. Franklin Allen et al., ``China's Financial System:
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53. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of Carl Walter, March 7, 2013.
54. Fox Business, ``China banks `significantly exposed' to shadow
financing: Fitch,'' April 10, 2013.
55. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Lynette H. Ong, March 7, 2013.
56. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Lynette H. Ong, March 7, 2013.
57. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Lynette H. Ong, March 7, 2013.
58. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Lynette H. Ong, March 7, 2013.
59. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Lynette H. Ong, March 7, 2013.
60. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Lynette H. Ong, March 7, 2013.
61. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Lynette H. Ong, March 7, 2013.
62. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Lynette H. Ong, March 7, 2013.
63. Financial Stability Board, ``Global Shadow Banking Monitoring
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64. David Luttrell, Harvey Rosenblum, and Jackson Thies,
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Practical Lessons Learned'' (Dallas, TX: Federal Reserve Bank of
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65. David Luttrell, Harvey Rosenblum, and Jackson Thies,
``Understanding the Risks Inherent in Shadow Banking: A Primer and
Practical Lessons Learned'' (Dallas, TX: Federal Reserve Bank of
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66. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of Regina M. Abrami, March 7, 2013.
67. Xiao Geng, ``Lending in the Dark,'' Project Syndicate, April
22, 2013.
68. Joe McDonald, ``China jails more than 1,400 in lending
crackdown,'' Associated Press, April 26, 2013.
69. Bloomberg News, ``China Shadow Bankers Go Online as Peer-to-
Peer Sites Boom,'' July 24, 2012.
70. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Regina M. Abrami, March 7, 2013.
71. Yaohui Zhao, ``Earnings Differentials between State and Non-
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72. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Sheridan Prasso, March 7, 2013.
73. KPMG International, Global Debt Sales, China, Third Edition,
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China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Sheridan Prasso, March 7, 2013.
77. Fox Business, ``China banks `significantly exposed' to shadow
financing: Fitch,'' April 10, 2013.
78. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Regina M. Abrami, March 7, 2013.
79. Ben Simpfendorfer, ``Guest post: the danger in China's shadow
banks and bank-trust products,'' Financial Times, November 22, 2012.
80. Gabriel Wilday and Shengnan Zhang, ``In China, off-sheet
lending risks lurk in the shadows,'' Reuters, April 9, 2013.
81. Simon Rabinovitch, ``China to Tighten Shadow Banking Rules,''
Financial Times, February 26, 2013.
82. Gabriel Wilday and Shengnan Zhang, ``In China, off-sheet
lending risks lurk in the shadows,'' Reuters, April 9, 2013.
83. Xiao Geng, ``Lending in the Dark,'' Project Syndicate, April
22, 2013.
84. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Regina M. Abrami, March 7, 2013.
85. Joe McDonald, ``China jails more than 1,400 in lending
crackdown,'' Associated Press, April 26, 2013.
86. Simon Rabinovitch, ``China to Tighten Shadow Banking Rules,''
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88. Xiao Geng, ``Lending in the Dark,'' Project Syndicate, April
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91. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Sheridan Prasso, March 7, 2013.
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97. Gabriel Wilday and Shengnan Zhang, ``In China, off-sheet
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98. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Regina M. Abrami, March 7, 2013.
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100. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of Regina M. Abrami, March 7, 2013.
101. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
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109. Dezan Shira & Associates, ``Shadow Banking Poses Hidden Risks
to China's Financial Sector,'' January 2012.
110. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Sheridan Prasso, March 7, 2013.
111. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
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lending risks lurk in the shadows,'' Reuters, April 9, 2013.
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complaints,'' Financial Times, December 27, 2012.
119. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
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120. Ryan Rutkowski, ``Local Government Financing Vehicles Under
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124. Joe McDonald, ``China jails more than 1,400 in lending
crackdown,'' Associated Press, April 26, 2013.
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crackdown,'' Associated Press, April 26, 2013.
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127. Paul Gillis, ``There's No Accounting for China's Accounting,''
Wall Street Journal, May 29, 2013.
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System: An Introduction and Overview'' (Washington, DC: John L.
Thornton China Center at The Brookings Institution, July 2013).
129. Ogilvy Public Relations, Daily China News Update (Washington,
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130. Economist, ``Served in China: Services are poised to become
the country's biggest sector,'' February 23, 2013.
131. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of John Dearie, March 7, 2013.
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133. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of John Dearie, March 7, 2013.
134. The American Chamber of Commerce in Shanghai, Viewpoint:
Financial Services in China: Capitalizing on the World's Fastest
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135. The American Chamber of Commerce in China, 2012 White Paper
(Beijing, China: 2012).
136. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of Steve Simchak, March 7, 2013.
137. The American Chamber of Commerce in Shanghai, Viewpoint:
Financial Services in China: Capitalizing on the World's Fastest
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138. U.S. House of Representatives, Financial Services Committee,
International Monetary Policy and Trade Subcommittee, Hearing on
Increasing Market Access for U.S. Financial Firms in China: Update on
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Honorable Robert S. Nichols, chairman, Engage China Coalition, 112th
Cong., 2nd sess., May 16, 2012.
139. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Paul Saulski, March 7, 2013.
140. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of Paul Saulski, March 7, 2013.
141. World Trade Organization. ``Guide to reading the GATS
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tratop----e/serv----e/guide1----e.htm.
142. C. Christopher Parlin, ``Current Developments Regarding the
WTO Financial Services Agreement'' (Washington, DC: International
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cdmfl/eng/parlin.pdf.
143. C. Christopher Parlin, ``Current Developments Regarding the
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cdmfl/eng/parlin.pdf.
144. Office of the United States Trade Representative, 2012 USTR
Report to Congress on China's WTO Compliance (Washington, DC: December
2012).
145. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of John Dearie, March 7, 2013.
146. U.S.-China Economic and Security Review Commission, Hearing on
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China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of John Dearie, March 7, 2013.
147. SouthCentre.Org, ``China Proposes WTO Discussion on Financial
Services Development: China's statement at the WTO's Committee on Trade
and Financial Services,'' June 29, 2010.
148. SouthCentre.Org, ``China Proposes WTO Discussion on Financial
Services Development: China's statement at the WTO's Committee on Trade
and Financial Services,'' June 29, 2010.
149. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Paul L. Gillis, March 7, 2013.
150. Dena Aubin and Olivia Oran, ``Chinese Companies Retreat from
U.S. Listings as Scrutiny Mounts,'' Reuters, January 14, 2013.
151. Bloomberg, ``Chinese Stocks Flee U.S. Exchanges,'' July 19,
2012.
152. Dena Aubin and Olivia Oran, ``Chinese Companies Retreat from
U.S. Listings as Scrutiny Mounts,'' Reuters, January 14, 2013.
153. Dena Aubin and Olivia Oran, ``Chinese Companies Retreat from
U.S. Listings as Scrutiny Mounts,'' Reuters, January 14, 2013.
154. Dena Aubin and Olivia Oran, ``Chinese Companies Retreat from
U.S. Listings as Scrutiny Mounts,'' Reuters, January 14, 2013.
155. Lewis H. Ferguson, Investor Protection through Audit Oversight
(California State University 11th Annual SEC Financial Reporting
Conference, Irvine, CA, September 21, 2012).
156. Kun-Chih Chen, Ying Chou Lin, and Yu-Chen Lin, Does Foreign
Company's Shortcut to Wall Street Cut Short their Financial Reporting
Quality? Evidence from Chinese Reverse Mergers (Singapore: Singapore
Management University, April 22, 2012).
157. Congsheng Wu, ``Dichotomy of Chinese Domestic and Overseas
IPOs: An Empirical Investigation'' (Bridgeport, CT: University of
Bridgeport, March 30, 2011. http://www.bridgeport.edu/files/6413/6597/
6609/publications----wu.pdf.
158. NYSE EURONEXT Listings Directory, Sinopec Shanghai
Petrochemical Company Limited. http://www.nyse.com/about/listed/
shi.html.
159. Yingjie Zhang, ``The Study on the Entry Mechanisms by Chinese
Companies to the U.S. Market'' (Albany, NY: State University of New
York at Albany, May 17, 2012).
160. Yingjie Zhang, ``The Study on the Entry Mechanisms by Chinese
Companies to the U.S. Market'' (Albany, NY: State University of New
York at Albany, May 17, 2012).
161. Lewis H. Ferguson, Investor Protection through Audit Oversight
(California State University 11th Annual SEC Financial Reporting
Conference, Irvine, CA, September 21, 2012).
162. SecuritiesLawyer101.com, Reverse Mergers 101, Hamilton &
Associates.
163. U.S. Securities and Exchange Commission, ``SEC Approves New
Rules to Toughen Listing Standards for Reverse Merger Companies''
(Washington, DC: November 9, 2011).
164. Matthew Mosk, ``Chinese Deny Turning Blind Eye to Investment
Scams,'' ABC News, January 10, 2013.
165. Elaine Buckberg, ``Recent Trends in U.S. Securities Class
Actions Against Non-U.S. Companies'' (The Harvard Law School Forum on
Corporate Governance and Financial Regulation, November 20, 2012).
166. Matthew Mosk, ``Chinese Deny Turning Blind Eye to Investment
Scams,'' ABC News, January 10, 2013.
167. Elaine Buckberg, ``Recent Trends in U.S. Securities Class
Actions Against Non-U.S. Companies'' (The Harvard Law School Forum on
Corporate Governance and Financial Regulation, November 20, 2012).
168. Paul Gillis, ``Who Audits China?'' China Accounting Blog,
November 22, 2011.
169. Paul Gillis, ``Who Audits China?'' China Accounting Blog,
November 22, 2011.
170. Michelle FlorCruz, ``Standoff Between U.S., Chinese Over
Audits of Chinese Firms Could Mean Delisting from U.S. Exchanges for
Many Chinese Companies,'' International Business Times, December 4,
2012.
171. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, written testimony of Cynthia Fornelli, March 7, 2013.
172. Michelle FlorCruz, ``Standoff Between U.S., Chinese Over
Audits of Chinese Firms Could Mean Delisting from U.S. Exchanges for
Many Chinese Companies,'' International Business Times, December 4,
2012.
173. Megan Mcardle, ``Accounting War,'' The Daily Beast, December
13, 2012.
174. Kathy Chu, Michael Rapaport, and Ben Dummett, ``SEC Probe Puts
China Listings in Doubt,'' Wall Street Journal, December 4, 2012.
175. Wang Yuqian, ``Big Four Accounting Firms Face New Regulatory
Challenges in China,'' China Briefing, March 2, 2012.
176. Wang Yuqian, ``Big Four Auditors Get Rules for
Restructuring,'' Caixin Online, May 10, 2012.
177. Ernest Scheyder, ``Caterpillar Writes Off Most of China Deal
After Fraud,'' Reuters, January 18, 2013.
178. Patrick Chovanec, ``Clash of the Balance Sheets,'' Foreign
Policy, December 12, 2012. http://www.foreignpolicy.com/articles/2012/
12/10/China----accounting----scandal----SEC----Baidu.
179. Cynthia Fornelli, ``Financial Reporting and Confidence in
Trading Markets'' (Center for Professional Education, Inc., SEC
Conference, Shanghai, China, June 21, 2011).
180. Lewis H. Ferguson, ``Investor Protection through Audit
Oversight'' (California State University 11th Annual SEC Financial
Reporting Conference, Irvine, CA, September 21, 2012).
181. Cynthia Fornelli, ``Financial Reporting and Confidence in
Trading Markets'' (Center for Professional Education, Inc., SEC
Conference, Shanghai, China, June 21, 2011).
182. Cynthia Fornelli, ``Financial Reporting and Confidence in
Trading Markets'' (Center for Professional Education, Inc., SEC
Conference, Shanghai, China, June 21, 2011).
183. Paul Gillis, ``Auditing Wars, Transnational Accounting
Regulation in China,'' Forensic Asia, January 15, 2013.
184. Paul Gillis, ``Auditing Wars, Transnational Accounting
Regulation in China,'' Forensic Asia, January 15, 2013.
185. Paul Gillis, ``There's No Accounting for China's Accounting,''
Wall Street Journal, May 29, 2013.
186. Paul Gillis, ``There's No Accounting for China's Accounting,''
Wall Street Journal, May 29, 2013.
187. Paul Gillis, ``There's No Accounting for China's Accounting,''
Wall Street Journal, May 29, 2013.
188. Paul Gillis, ``Solving Regulatory Battles,'' China Accounting
Blog, September 19, 2013.
189. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of John Dearie, March 7, 2013.
190. U.S.-China Economic and Security Review Commission, Hearing on
Corporate Accountability, Access to Credit, and Access to Markets in
China's Financial System: Rules and their Ramifications for U.S.
Investors, testimony of John Dearie, March 7, 2013.
191. Didi Kirsten Tatlow, ``Is Something Toxic Buried in China's
Financial System?'' New York Times, January 17, 2013. http://
rendezvous.blogs.nytimes.com/2013/01/17/is-something-toxic-buried-in-
chinas-financial-system/.
192. Huw Jones, ``Shadow Banks Face 2015 Deadline to Comply with
First Global Rules,'' Reuters, August 29, 2013. http://www.reuters.com/
article/2013/08/29/us-g20-shadowbanking-rules-idUSBRE97S0TX20130829.
193. Xu Qiyuan, ``China needs to set its services free,'' Financial
Times, April 15, 2013. http://www.ft.com/intl/cms/s/0/564dbddc-a5ba-
11e2-b7dc-00144feabdc0.html-#-ax-zz-2-Rot4eLM6.
SECTION 4: CHINA'S AGRICULTURE POLICY,
FOOD REGULATION, AND THE U.S.-CHINA
AGRICULTURE TRADE
Introduction
China's World Trade Organization (WTO) accession in 2001
was a watershed event for U.S. agriculture. China is now the
primary export market for U.S. agriculture products.\1\ While
the United States ran a $315 billion trade deficit in goods
with China in 2012, it achieved a $21 billion surplus in
agriculture.\2\ Since full implementation of the WTO accession
in 2005, China's agriculture imports from the United States
have risen by an average of $2.5 billion each year, exceeding
the U.S. Department of Agriculture's (USDA) initial estimate of
$2 billion.\3\
A prime beneficiary of this farm trade boom is Iowa, one of
the nation's largest agricultural states.\4\ Twenty years ago,
China and Taiwan accounted for 6 percent of Iowa's agricultural
exports. By 2012, they accounted for over 20 percent. That has
helped sales of Iowa's agricultural products triple to $30
billion in just a decade.\5\ Iowa farm real estate is now worth
three times the national average.\6\ Moreover, Iowa has
enhanced the U.S.'s agriculture diplomacy with China. Iowa
officials claim a ``special relationship'' with China's new
president, Xi Jinping, who spent time in the state as a young
official.\7\ U.S. Agriculture Secretary Tom Vilsack in February
2012 hosted Mr. Xi and Agriculture Minister Han Changfu at the
first U.S.-China Agricultural Symposium in Des Moines. The two
countries signed the first U.S.-China Plan of Strategic
Cooperation in Agriculture (2012-2017).\8\ Weeks after the
symposium, the USDA led the largest ever agricultural trade
mission to the Mainland.\9\
The Commission consequently chose Iowa State University in
Ames as the location for an April hearing on China's
agriculture policy and the U.S.-China trade in agriculture
products. Among the witnesses was Iowa Secretary of Agriculture
William Northey. The Commissioners also traveled to China in
July to meet with Chinese officials, researchers, and producers
as well as U.S. food companies. These activities complemented
the Commission's 2008 hearing in New Orleans, which examined
the economic and safety impacts of China's seafood exports to
the United States.\10\
The hearing and trip illustrated the potential for
deepening U.S.-China agriculture ties. China must feed a fifth
of the world's population with less than a tenth of its arable
land and potable water.\11\ As China transforms into an urban
society with a growing middle class, per capita food
consumption is rising and, with it, the demand for higher-
protein diets--a demand that U.S. farmers are well positioned
to fill. China also seeks to make its farmers more productive,
and U.S. agencies, companies, and universities are helping
China to do that. The United States, with its distinct
advantages in resources, productivity, and quality, should
benefit from a free market in farm goods.
However, the Commission takes note of serious problems in
the bilateral relationship. These problems are detailed in this
section. Many in the U.S. agriculture industry lobbied Congress
in 2000 to grant China permanent normal trade relations,
because they expected China to become a major purchaser of U.S.
food products once it joined the WTO.* But yesterday's farm
belt advocates have been disappointed that China has
concentrated its purchases on bulk commodities, such as
soybeans used as animal feed for China's outsized livestock
industry (see figures 1 and 2). China's agriculture policy
favors domestic production, even when it is unsustainable and
nonessential to food security. In trade, China has used
nontariff barriers to restrict imports of higher value-added
products from the United States. Of particular concern are
antidumping duties on U.S. broiler chickens; a ban on U.S.
beef; and zero tolerance for even the small amounts of growth-
inducing chemicals used in U.S. pork feed lots. For the bulk
goods that China does import, such as soybeans, cotton, and
corn, value-added processing largely takes place in China,
costing the United States opportunities to create new jobs.
---------------------------------------------------------------------------
* Granting China permanent normal trade relations, also known as
Most Favored Nation status, was a precursor to China's admission to the
WTO the following year. President Bill Clinton also pushed for
permanent normal trade relations as a way to widen access for U.S.
agricultural exports to China. The White House, ``Clinton Says U.S. Has
Key Role in China'' (Washington, DC: Office of the Press Secretary,
February 24, 2000). For a comprehensive forecast of market access by
product, see Jonathan R. Coleman, Jonathan T. Fry, and Devry S.
Boughner, ``The Impact of China's Accession to the WTO on U.S.
Agricultural Exports'' (Washington, DC: U.S. International Trade
Commission, September 2002).
Figure 1: Value and Composition of U.S. Agricultural Exports to China,
2002-2012
US$ billions
Source: USDA (Washington, DC: Foreign Agricultural Service, 2013).
Figure 2: Basic Composition of U.S. Agricultural Exports to China and
to the World, 2012
Share (%)
Notes: Due to a rounding error, totals may not add up to 100.
Under the USDA's classification system, ``bulk commodities'' refer
to crops shipped in raw form, such as wheat, coarse grains, rice,
soybeans, and cotton; ``intermediate goods'' refer to processed crops,
such as flour, soybean meal, and feeds and fodders as well as products
not directly for consumer use, such as live animals, planting seeds,
hides and skins, and sweeteners; ``consumer-oriented products''
include, among others, meat and dairy products, fruits and vegetables,
and snack foods.
Source: USDA (Washington, DC: Foreign Agricultural Service, 2013).
The emerging trade relationship with China also poses risks
to the food industry on U.S. shores. China has not done enough
to promote food safety for its own people but maintains a trade
surplus with the United States in consumer foods. U.S.
consumers eat large amounts of fish, fruits, and vegetables, as
well as vitamins and food supplements, produced in China.* U.S.
government food safety inspectors have been unable to
sufficiently monitor the safety of these imports and have been
restricted, too, in their access to food production sites
within China. At the same time, Chinese food companies, led by
pork producer Shuanghui Group, are beginning to acquire
productive assets in the U.S. food sector. Such investments
could improve China's food production by helping its companies
to adopt best practices. For the United States, they also have
implications for net economic benefits, intellectual property,
and reciprocal market access.
---------------------------------------------------------------------------
* For more information, see U.S.-China Economic and Security Review
Commission, Hearing on China's Enforcement of Intellectual Property
Rights and the Dangers of the Movement of Counterfeited and Pirated
Goods into the United States (Washington, DC: June 7-8, 2006).
---------------------------------------------------------------------------
China's Changing Consumption Needs
China's economic development over the past 30 years has
caused a structural shift in the country's dietary habits. In
1980, China consumed 68 percent less meat per capita than the
world average; today, it consumes 19 percent more.\12\ There is
still room for additional meat consumption. Although economic
growth is slowing, China's population of 1.3 billion is seeing
a faster rise in real wages than previously, and just over half
of the population now lives in cities. Urbanization and higher
incomes tend to correlate with protein-based diets.* Owing to
income inequality among regions, rural and urban areas, and
individual households, meat is enjoyed mostly by a small
segment of China's population.
---------------------------------------------------------------------------
* A more technical explanation of this phenomenon is the income
elasticity of demand, or how much demand for a given product rises or
falls with increases in income. Income elasticities in China, as in
many other countries, have been negative for rice, wheat, and coarse
grain, such that China consumes less of these products as it becomes
wealthier. By contrast, its consumption of pork, poultry, and
especially beef and fish will continue to rise rapidly with added
income. Scott Rozelle, ``Overview of China's Agricultural Development
and Policies'' (Center for Chinese Agricultural Studies, January 2010).
---------------------------------------------------------------------------
Chinese consumers could also diversify their dietary
intake. China currently consumes around half of the world's
pork, equivalent to 30 kilograms of pork per capita each year,
far higher than the rest of the world. In contrast, its
consumption of beef and poultry is relatively low. Poultry
consumption per capita is about ten kilograms per year,
compared to 42.4 kilograms in the United States (see figure 3).
Poultry is a lower-cost option for increasing protein intake.
Speaking on behalf of the U.S. Poultry and Egg Export Council,
which represents 95 percent of the U.S. poultry industry, DTB
Associates' Kevin Brosch forecast the impact that China would
have on world markets if it increased its annual per capita
consumption of poultry: at Japan's modest level of 17 kilograms
per annum, China would require an amount equal to all current
world exports of poultry.\13\
Figure 3: Per Capita Meat Consumption: China vs. Other Countries, 2012
Kilograms per capita per year
Source: Organization for Economic Cooperation and Development
(OECD)/Food and Agriculture Organization (FAO), Agriculture Outlook,
June 2013, via U.S. Meat Export Federation (Denver, CO).
China's distinct dietary preferences provide additional
opportunities to U.S. producers. The United States has a
surplus of exactly those parts of the animal, such as pork
offal and chicken paws, that Chinese consumers prize. These
products can be sold at a much higher price in China than the
United States.\14\ The U.S. meat products exported to China are
predominantly in these categories.\15\ As Dermot Hayes of Iowa
State University told the Commission, if U.S. producers could
sell the other half of the carcass in China at a premium, they
could double their revenue without significant production cost
increases.\16\
As Chinese consumers change their diets, they are seeking
safer food as well. Some of this vigilance has resulted in
suspicion of new technologies, such as genetically modified
foods.* A spate of food safety scandals in China has also made
consumers justifiably worried about what they are eating.
China's food production industry is highly fragmented. Many
producers at the farming, processing, and distribution levels
forgo safe practices in order to cut costs.\17\ Food is
adulterated, among other things, by the excessive use of
fertilizers and pesticides; growth-enhancing antibiotics for
livestock; and toxic chemicals that artificially enhance the
freshness, appearance, or nutritional value of food. Due to
false or incomplete labeling, harmful ingredients are often not
disclosed.\18\
---------------------------------------------------------------------------
* The Chinese public remains very divided about genetically
modified (GM) foods. Some critics, inspired by Japan and the European
Union, maintain that GM foods are not safe for either production or
consumption. Oddly, China has yet to legalize the planting of GM crops,
even though it has invested large amounts in developing its own
biotechnology. China does, however, import GM crops, such as soybeans
and corn, which are fed to China's livestock. Some argue that this
intermediate form of GM food consumption is less obvious to consumers
and hence less controversial. Jikun Huang et al., ``A Consumer
Segmentation Study with Regards to Genetically Modified Food in Urban
China,'' Food Policy 35 (2010): 456-62.
---------------------------------------------------------------------------
In response, Chinese citizens, with the aid of new social
media, are seeking more information about food safety beyond
government sources. Many have voiced grievances about a
``special food supply'' that caters to government
officials. Chinese consumers are also transitioning
from wet markets to supermarkets,= in the process becoming more
attentive to third-party labeling, traceability, and trusted
brands.\19\ Those with more disposable income are turning to
premium food products to ensure safety. Interest in organic
food is spreading, ranging from farmers' markets to community
farming and organic food clubs.\20\ On the outskirts of Xi'an
in western China, the Commission visited a company that
combines a vegetable seed business with organic food
production. Members of the company's organic food service pay
an annual fee of around $800 to have organic food shipped to
their homes.\21\
---------------------------------------------------------------------------
``Special food supply'' refers to food for Chinese
officials grown at special production sites. The system was first
established under Soviet influence in the 1930s as a means to protect
the Communist Party leadership against famine. Today, special food
supply sites in China are associated with organic food production.
While the precise quantity and nature of these production sites is
unclear, articles in the Chinese media indicate that the ``special food
supply'' has caused some consternation among ordinary Chinese. Barbara
Demick, ``In China, What You Eat Tells Who You Are,'' Los Angeles
Times, September 25, 2011, via Factiva database; Jiang Gaoming, ``Jiang
Gaoming: Shipin tegong jidi pinxian tuxian shipin jianguan ganga''
(Jiang Gaoming: The Appearance of New Special Food Supply Sites Is an
Embarrassment to China's Food Regulators), Guangming Wang (Guangming
Net), February 25, 2013. http://health.gmw.cn/2013-02/25/
content-_-6800842-.-htm; Nandu online, ``Hu Xingdou: Jianyi quxiao
tegong zhidu, jiejue tequan fubai'' (Hu Star: Recommendations on
Eliminating the Special Food Supply System, and Resolving the
Corruption of Special Privilege), May 14, 2013. http://
ndnews.oeeee.com/html/201305/14/59741.html; and Fazhi Ribao (China Law
Daily), ``Tegong shangpin wushi zhengce, xuezhe cheng bufen guojia
jiguan tan xiaoli,'' (Special Supply Products Unregulated, Scholars
Ascribe It to Greed in Some Government Agencies), February 2, 2012.
http://politics-.-people-.-com-.-cn/BIG5/16998050.html.
= A wet market is a fresh food market commonly found in Asian
countries. It often sells live animals and raw meat.
---------------------------------------------------------------------------
Worries about food safety are also boosting food imports. A
striking example is the dairy sector. The adulteration of
infant formula with melamine, a toxic industrial solvent,
caused China's dairy imports to grow at an annualized rate of
45 percent between 2009 and 2012--more than double the previous
rate and double the rate of increase in total food imports.\22\
Mainland Chinese are buying baby formula and ultra-high-
temperature milk from the shelves of supermarkets in other
countries, where retailers have been compelled to ration sales
to limit hoarding.\23\
Reacting to the rise in consumer demand, the Chinese
government has begun to allow some imports of U.S. premium
consumer foods bearing the ``USDA approved'' logo. U.S. pear
farmers, for example, received import licenses from Beijing in
early 2013 and plan to focus on wealthy consumers concerned
about the safety of domestic pears.\24\ These U.S. products
often directly compete with goods produced in China.
------------------------------------------------------------------------
------------------------------------------------------------------------
Examples of Food Safety Scandals in China
In recent years, food safety scandals in China have affected a variety
of consumer food items:
Dairy Products
Melamine mimics the nutritional values of protein. It has been used in
China to mask the low protein content of dairy products, such as milk
powder and infant formula. In 2008, six infants were killed, and more
than 12,000 were hospitalized with kidney and other organ damage from
adulterated formula. The scandal led to the execution of two producers
and prison terms for dairy company executives. In February 2011, reports
emerged of another milk contamination scandal involving leather-
hydrolyzed protein. The toxic additive has also been found in such
processed products as candy, hot cocoa, and flavored drinks, some of
which are exported from China to other countries.
Fruits, Vegetables, and Tea
Police in the northeastern city of Shenyang seized 40 tons of bean
sprouts in 2011 that had been treated with sodium nitrite, urea,
antibiotics, and plant hormones. Wholesale vegetable dealers in Shandong
Province in 2012 were found spraying cabbages with formaldehyde to
preserve them during transport without refrigeration. Chinese media in
2012 reported that fruit from 16 companies contained excessive pigments,
bleaching agents, and preservatives. Testing by Greenpeace found at
least three different kinds of pesticides in each of 18 varieties of
tea.
------------------------------------------------------------------------
------------------------------------------------------------------------
------------------------------------------------------------------------
Examples of Food Safety Scandals in China--Continued
Meat and Fish
Pork is sometimes adulterated with clenbuterol, a lean meat additive
that can cause dizziness, heart palpitations, and diarrhea. Other
reports have identified pork contaminated by phosphorescent bacteria,
while rat meat has been substituted for lamb sold on skewers in Beijing.
A 2012 report revealed that fish vendors in Beijing were using a
chemical ordinarily meant for temporary dental fillings in order to
tranquilize fish during transport.\25\
------------------------------------------------------------------------
China's Unsustainable Agriculture Policy
The Focus on Self-Sufficiency and Domestic Production
China has seen the fastest growth in agricultural output of
any major economy over the past 30 years. In the Maoist period
(1949-76), agronomists feared that China would place a strain
on the world food system by being unable to feed itself. Today,
China produces over 20 percent of the world's cereal grains, 25
percent of the world's meat, and 50 percent of the world's
vegetables.\26\ Based on a common definition of arable land,
the United States has more than twice the cropland of China,
yet China's output is two-and-a-half times that of the United
States.* China feeds not only its own population of 1.3
billion--it is also the world's largest exporter of numerous
foods, including apple juice, farm-raised fish, garlic, and
vitamin C.\27\
---------------------------------------------------------------------------
* China has achieved greater agricultural output than the United
States with a smaller share of arable land. As outlined in this
section, this phenomenon is mainly attributable to the intensive and
unsustainable use of labor, resources, and land. Dense livestock
production, double-cropping, overuse of fertilizers and pesticides, and
land reclamation in arid regions are some examples of intensive farming
methods. Relative to the United States, the productivity of China's
farming sector remains very low. U.S.-China Economic and Security
Review Commission, Hearing on China's Agriculture Policy and U.S.
Access to China's Market, testimony of Dermot Hayes, April 25, 2013.
---------------------------------------------------------------------------
Beijing's agriculture policy has played a role in enhancing
China's food productivity. Until the late 1970s, the government
mostly procured agricultural goods from farmers at below-market
rates. Reforms in the 1980s allowed farmers to sell some
production on the open market at a higher return and
established a land contracting system that permitted the
leasing of land for several decades. Beginning in the 1990s,
China's opening to world markets led to more export-oriented
production, inbound foreign direct investment, and
international development support from aid agencies such as the
United Nations and the World Bank.\28\
The government is seeking ways to further modernize the
agriculture sector. Crop yields, for instance, are still below
potential due to poor planting techniques and postharvest
waste. The government has responded with ambitious
measures. Since joining the WTO, China has increased its
research and development (R&D) spending on agriculture more
rapidly than any other country.\29\ China's 12th Five-Year Plan
(2011-2015) for the first time shifts the explicit focus of
agriculture policy from rural development to boosting
agricultural output. It lays out a blueprint for consolidating
industry, modernizing production facilities, and promoting
regional specialization.\30\ The 12th Five-Year Plan has been
complemented by the No. 1 Document--China's first policy
document each year, which since 2004 has been devoted to
agriculture. The most recent No. 1 Document, issued in January
2013, summarizes a comprehensive set of policies, including
incentives for new farming operations; corporate investment in
agriculture; food grain security measures; and credit for
farmers.\31\ During the Commission's July 2013 trip to China,
participants met with top scientists at the Chinese Academy of
Agriculture Sciences who are exploring ways to boost
productivity through farmer training, satellite mapping,
biotechnology, and reclamation of arid and polluted soils.\32\
---------------------------------------------------------------------------
Postharvest waste refers to the loss in the process of
storing grain after it is harvested. In China, grain crops are often
exposed to adverse natural elements due to the lack of adequate storage
facilities. Shannon Herzfeld (vice president, Archer Daniels Midland),
telephone interview with Commission staff, Washington, DC, August 9,
2013.
---------------------------------------------------------------------------
However, many of China's agricultural policies are
inefficient and unsustainable. These policies are driven, in
part, by the government's emphasis on attaining self-
sufficiency across a broad spectrum of food products, when a
more rational policy would be to import products for which
China lacks a comparative advantage. Beijing keeps official
targets of 95 percent self-sufficiency for corn, wheat, and
rice. In practice, it also maintains near self-sufficiency for
pork, poultry, and beef (see table 1). According to a typically
optimistic forecast by Huang Jikun, a top researcher at the
government's Chinese Academy of Science's Center for Chinese
Agricultural Policy, China by 2025 will have no trade deficit
in either meat products or wheat and rice and will continue to
be a net exporter of fruits, vegetables, and farm-raised
fish.\33\
Table 1: China's Self-Sufficiency in Beef, Pork, and Broiler Chickens,
2009-2012
1,000 metric tons per year
------------------------------------------------------------------------
2009 2010 2011 2012
------------------------------------------------------------------------
Beef
Production 5,764 5,600 5,550 5,540
Consumption 5,749 5,589 5,524 5,597
Surplus/deficit 15 11 26 (57)
Surplus/deficit share of 0.3% 0.2% 0.5% -1.0%
consumption
------------------------------------------------------------------------
Pork
Production 48,905 51,070 49,500 52,350
Consumption 48,823 51,157 50,004 52,275
Surplus/deficit 82 (87) (504) 75
Surplus/deficit share of 0.2% -0.2% -1.0% 0.1%
consumption
------------------------------------------------------------------------
Broiler chickens
Production 12,100 12,550 13,200 13,700
Consumption 12,210 12,457 13,015 13,543
Surplus/deficit (110) 93 185 157
Surplus/deficit share of -0.9% 0.7% 1.4% 1.2%
consumption
------------------------------------------------------------------------
Source: USDA, ``Livestock and Poultry: World Markets and Trade,''
(Washington, DC: Foreign Agricultural Service, April 2013). http://
www.fas.usda.gov/psdonline/circulars/livestock--poultry.pdf.
Misallocation of Resources for Meat Production
A central problem of China's agriculture policy is its
concentration on livestock production. China accounts for half
of the world's pork output. It is also the world's largest
producer of farm-raised fish, second-largest producer of
poultry, and third-largest producer of beef.\34\ Meat is an
inefficient way to deliver calories, as it requires land- and
water-intensive production of grain crops to feed animals
instead of humans. For example, 1,799 gallons of water may be
required over the life of a cow before it is slaughtered.\35\
China's low productivity, coupled with its lack of resources,
exacerbates these inefficiencies.
China lags far behind the United States in its ability to
convert livestock into meat. China last year bred 15 percent
more cattle than the United States--104 million head--but
produced less than half as much beef. China produced five times
more pork than the United States but required seven times as
many hogs.\36\ Nor is productivity necessarily improving over
time. China's hog herd grew by 0.6 percent per annum in the
2000s, compared to 2.7 percent in the 1990s. China's pork
output slowed even more over the two decades, from 5.9 percent
to 2.2 percent per year.\37\ Following an outbreak of blue ear
pig disease * that killed off much of the herd, China's pork
production actually contracted by 7.8 percent in 2007.\38\ In
contrast, the United States is achieving record pig herds and
pork output, due to improved genetics and swine management
techniques that have had more baby pigs survive to
maturity.\39\
---------------------------------------------------------------------------
* Blue ear pig disease, also known as porcine reproductive and
respiratory syndrome, is a pandemic disease that causes reproductive
failure in breeding stock and respiratory tract illness in young pigs.
It was first reported in North America in the 1980s.
---------------------------------------------------------------------------
As a consequence of livestock production, China is using
scarce resources to produce grain crops for animal feed. In the
1990s, China began to devote more acreage to horticulture cash
crops. Yet over the past decade, that reallocation of land has
slowed, such that grain crops still account for 68 percent of
sown land (see figure 4). Within the grain sector, corn has
overtaken rice as China's most widely planted and produced
crop--reflecting the booming demand for corn feed.\40\
China's focus on grain crops has also diverted valuable
water resources to what is a less profitable crop. According to
Dr. Hayes, it has been bad business for China's farmers:
Consider the human resource waste when a skilled farmer
spends an entire year growing three acres of corn in a
world where a single U.S. farmer can grow three
thousand acres. If China were to allow the market to
incentivize these farmers to grow high value crops such
as flowers, fruits, vegetables and ornamental plants,
total farm income and the value of farm output would
soar.'' \41\
Figure 4: Distribution of Sown Area in China, 2002-2012
Share (%)
Note: Due to a rounding error, totals may not add up to 100.
Source: National Bureau of Statistics, via CEIC database.
In spite of China's commitment to planting grain crops,
domestic crops have not sufficed to feed all of the country's
livestock. The government in the late 1990s began to sanction
imports of soybeans as an alternative source of animal feed.
China now imports four-fifths of the soybeans it consumes (see
figure 5).\42\ But even soybean imports are proving too little
to meet China's need for feed grains. In 2010, China for the
first time imported large quantities of corn. A recent Iowa
delegation to China testified that corn imports will keep
rising.* While these developments may bode well for U.S. corn
farmers, the fact is that China is tacitly abandoning its 95
percent self-sufficiency policy for corn, even as it promotes
its own large-scale corn production.
---------------------------------------------------------------------------
* When traveling to southern China in March 2013, a group from the
Iowa Soybean Association heard an estimate from a private trader that
China would be importing 20 million metric tons of corn in five years,
up from small amounts of net corn imports today. U.S.-China Economic
and Security Review Commission, Hearing on China's Agriculture Policy
and U.S. Access to China's Market, testimony of William Northey, April
25, 2013.
Figure 5: Import Penetration of Major Crops in China, 2002-2012
Imports/Domestic Utilization (%)
Source: Food and Agriculture Organization, Agricultural Market
Information System (Rome, Italy: Agricultural Information System:
Secretariat). http://www.amis-outlook.org/.
The Impact of Food Production on China's Environment and Public Health
China's land and resources face rapid decline. It is
doubtful whether the central government's target of maintaining
120 million hectares under cultivation can be met in the
future. According to Dr. Hayes, China will continue to lose
about 2.5 million acres, or up to 4 percent of its farm land,
each year to urban development.\43\ The remaining arable land
is also becoming less useful. China's intensive fertilizer use
per acre, the highest in the world, reduces soil fertility,
causing a vicious cycle of ever more fertilizer application to
achieve higher yields. Meanwhile, agriculture irrigation
accounts for 65 percent of China's water withdrawal, compared
to 40 percent in the United States.\44\ Water tables in arid
regions are being depleted.\45\
Pollution of China's water, soil, and climate directly
impact food quality. Only 6 percent of China's agricultural
products were considered pollution free in 2005, according to
figures compiled by the USDA. A study released in February 2011
found that 10 percent of all rice sold in China was
contaminated with heavy metals.\46\ Agriculture is a victim,
but also a cause, of pollution. China's first national
pollution census, released in February 2010, found that
agriculture is a bigger source of water pollution than
industry.\47\ In order to produce vast quantities of pork,
poultry, and farm-raise fish on limited land, China's breeders
have resorted to high livestock density. For instance, China
has kept five times the number of breeding sows--50 million--as
the United States on much less farmland.\48\ Consequently,
livestock farms in China currently produce about four billion
tons of manure annually. Manure could be used as nitrogen
fertilizer for cornfields, but in China manure more often ends
up as waste, because corn is planted in other regions of the
country.* That creates oxygen-depleting algae blooms and
nutrient overloads in waterways, including the Yangtze and
Yellow rivers. Not least, manure contributes to climate change
by emitting methane gas into the atmosphere.\49\
---------------------------------------------------------------------------
* China has been trying to diversify its hog production out of the
Yangtze Delta into other parts of the country, particularly the North,
where China's grain crops are grown. However, these efforts have had
limited success. Northern China's hog production has remained around
one-quarter of hog production since 1995. Kevin Chen and Wang Jimin,
``Hog Farming in Transition: The Case of China'' (paper presented at
Asian Livestock: Challenges, Opportunities and the Response, Proceeding
of an International Policy Forum, Bangkok, Thailand, August 16-17,
2012), p. 77; Mindi Schneider, ``Feeding China's Pigs: Implications for
the Environment, China's Smallholder Farms, and Food Security''
(Minneapolis, MN: Institute for Agriculture and Trade Policy, May
2011), p. 3.
---------------------------------------------------------------------------
Dense livestock production has increased the incidence of
animal diseases as well. In 2013, thousands of diseased pig
cadavers were found floating in the river near Shanghai, dumped
by illegal pork producers seeking to evade local food
inspectors.\50\ Similarly, in the poultry sector, the density
of fowl has turned China into a breeding ground for avian
influenza, with the most recent H7N9 outbreak occurring earlier
in 2013.\51\ According to Fred Gale of the USDA, these animal
disease outbreaks should ``drive the [Chinese] leadership to
acknowledge that the production of livestock has really grown
beyond the carrying capacity of the country.'' \52\
In contrast, U.S. meat production is more environmentally
sustainable than in China. In Iowa, where corn and pork are
produced side by side, manure is used as nitrogen fertilizer,
and corn is harvested at the source where it is needed, forming
a localized, low-cost, and self-sustaining production cycle.
Said David Miller of the Iowa Farm Bureau:
From an environmental perspective, there is significant
room for Iowa to increase pork production. Currently,
Iowa farmers apply about one million tons of nitrogen
from commercial fertilizer on Iowa farms and about
250,000 tons of nitrogen from manure. About 70 percent
of the manure-based nitrogen is from hog production. If
all of the commercial nitrogen for corn were to be
replaced by nitrogen from hog manure, the Iowa hog herd
would need to be currently five times as large as it is
for increased production.\53\
The Cost of Domestic Production for Chinese Consumers
In addition to the food safety risks discussed above,
China's consumers worry about prices. Food has been the main
driver of consumer inflation, which reached historic highs in
the 2000s (see figure 6). Said Dr. Hayes, ``They joke over
there that the CPI [consumer price index] means consumer pig
index, because if you spend 40 to 50 percent of your income on
food, the thing you want to do is to upgrade to meat, and when
that goes high, the Chinese government senses insecurity.''
\54\ Periods of unrest, such as the 1989 Tiananmen Square
protests, have been accompanied by high inflation.\55\ The
Great Famine in 1958-1961, which killed an estimated 15 million
to 40 million people on account of faulty government policy, is
etched in China's national psyche.\56\
Figure 6: Annual Consumer Price Inflation in China, 1996-2012
Year-on-year (%)
Source: National Bureau of Statistics via CEIC database.
A policy of domestic meat production further raises costs.
According to Dr. Hayes, feed costs alone make China's pork
production and farm-level livestock 40 percent more expensive
than in the United States. Soy meal prices are typically $100
per ton and corn $3 per bushel higher in China than in the
United States, owing to shipping costs.\57\ In view of China's
widening income gaps, the burden of higher prices is especially
harmful to low-income households that are forced to spend more
on meat products.\58\
Lack of Support for Rural Livelihoods
An underlying rationale for China to favor domestic
production is to support the nation's farmers. According to the
Central Intelligence Agency, one in three Chinese workers is
still active in agriculture.* Agriculture net output accounts
for 10 percent of China's GDP--compared to 1 percent in the
United States. China's market reforms have not done
nearly as much to improve the well-being of the rural
population as they have for the urban sector. Wages have risen
much faster in cities, widening rural-urban disparities. Young
people are leaving villages in droves to earn higher wages in
factories.\59\ China's National Bureau of Statistics estimates
that China has 170 million migrant workers.\60\
---------------------------------------------------------------------------
* Due to China's large migrant population, off-farm employment in
the rural sector, and subpar demographic data, there are varying
estimates of the total population economically
active in agriculture. See Central Intelligence Agency, World Factbook
(McLean, VA). https://www.cia.gov/library/publications/the-world-
factbook/fields/2048.html; Scott Rozelle, ``Overview of China's
Agricultural Development and Policies'' (Center for Chinese
Agricultural Studies, January 2010); and Peter Hooper et al,
``Demographics and GDP Growth in China'' (Frankfurt, Germany: Deutsche
Bank, November 16, 2012).
Net output refers to ``agriculture, value added,'' which
the World Bank defines as ``the net output of a sector after adding up
all outputs and subtracting intermediate inputs. It is calculated
without making deductions for depreciation of fabricated assets or
depletion and degradation of natural resources.'' World Bank Indicators
(Washington, DC: World Bank). http://data.worldbank.org/indicator/
NV.AGR.TOTL.ZS.
---------------------------------------------------------------------------
Maintaining rural livelihoods became a top priority for the
Chinese leadership under the administration of President Hu
Jintao and Premier Wen Jiabao (2003-2012). A document released
at a central work meeting on rural development in December 2005
stated: ``Only when the problems relating to agriculture, rural
areas, and the farmers have been solved properly, can China's
economy develop in the correct direction.'' \61\ The government
enshrined these initiatives in the 11th Five-Year Plan for
Agriculture (2006-2010), under the theme of ``building a new
socialist countryside.'' \62\ In 2006, all farmers were exempt
from an agricultural tax that had been in place for
millennia.\63\ These policies built on the agricultural reforms
initiated by Deng Xiaoping under the so-called ``three rural
issues,'' shorthand for the need to raise agricultural
productivity, boost rural incomes, and provide welfare to rural
migrants.\64\
The leadership under Xi Jinping is now changing tack by
encouraging an ambitious urbanization strategy. The goal is to
fully integrate 70 percent of the country's population, or
roughly 900 million people, into city living by 2025.\65\ With
a smaller rural population, agriculture could be concentrated
around a core of wealthier farmers. Fewer farm laborers would,
in theory, also make farmland more productive. Mechanization of
cropland, for instance, could raise planting density, while
larger pork feed lots would enhance efficiency and safety.\66\
Nonetheless, a policy of urbanization and agricultural
modernization will be difficult to realize. For one, China's
successes in food production have relied heavily on labor
intensity. Chinese farmers have planted multiple crops on the
same land each year. A large portion of the country's livestock
has been fed on manually collected food scraps and waste from
restaurants. Low-wage farm workers have reclaimed land in rocky
areas and hillsides that would not be considered arable in the
United States.\67\ In areas where bees have become extinct,
farmers have pollinated trees by hand.* As farm labor declines,
China will have to find means to mechanize and scale up
production.
---------------------------------------------------------------------------
* In line with a global trend, bees in China are becoming extinct.
China's farmers therefore pollinate many horticultural crops by hand
using artificial pollen substitutes. Stephen Holden, ``In Fields and
Hives, Zooming In On What Ails Bees,'' New York Times, June 11, 2013.
http://movies.nytimes.com/2013/06/12/movies/more-than-honey-a-
documentary-by-markus-imhoof.html.
---------------------------------------------------------------------------
To this end, the government is experimenting with models to
consolidate land. Yet, the institutional structures currently
in place are not conducive to a U.S.-style system of
production. China's average farm size is just 1.5 acres, down
from 1.7 acres 20 years ago.\68\ U.S. farms average 600 acres.
The few large farms that are being established make only a
small dent in overall production; in the pork sector, for
instance, backyard farmers and small, specialized farms account
for four-fifths of output.\69\ Further, China's complex system
of land distribution, whereby rural collectives led by local
officials reserve the right to allocate land to farmers, rural
enterprises, and urban developers, is politically contentious
and has frequently led to expropriation. The government
took a step forward in 2003 by banning large reallocations of
land and permitting farmers to lease land to locals and
nonlocals. That gave rise to a rental market that allowed less
productive farm workers to relocate to cities. But to this day,
land is owned at the village level and cannot be mortgaged.\70\
Farmers' cooperatives in the United States help farmers to
coordinate and scale up their production, but in China, only
one in four villages hosts a cooperative. In an authoritarian
system that restricts freedom of organization, local officials
can curb the independence of cooperatives as well.*
---------------------------------------------------------------------------
The policy that land should be contracted for 30 years
with no adjustments became law when the Land Management Law was revised
in 1998. Samuel P.S. Ho and George C.S. Lin, ``Emerging Land Markets in
Rural and Urban China: Policies and Practices,'' China Quarterly 175
(September 2003): 689-707.
* The technical term for China's cooperatives is ``farmers'
professional economic cooperative.'' Data from a 2009 survey by the
Center for Chinese Agricultural Policy. Scott Rozelle, ``Overview of
China's Agricultural Development and Policies'' (Beijing, China: Center
for Chinese Agricultural Policy, January 2010).
---------------------------------------------------------------------------
The absence of a functioning welfare state in China poses a
further obstacle to modernizing agriculture. The government has
yet to reform the system of residence permits (hukou) in urban
areas that would grant all rural migrants access to urban
welfare provision (For more on urbanization, see chap. 1, sec.
1, of this Report.). Independent surveys show that younger
family members are migrating to cities temporarily, while the
elders stay behind to tend the land.\71\ Farmland, leased for
30 years, remains an important form of personal insurance that
many migrants are reluctant to give up.
The Impact of China's Agriculture Policy on U.S. Exports
Measuring the Impact of China's WTO Violations
Prior to its WTO accession, China's trade barriers included
exorbitant tariffs, quotas, state trading monopolies, and
outright bans on some agricultural products. China agreed to
eliminate most of these barriers. In 2002-2006, China lowered
tariffs on agricultural goods of greatest importance to U.S.
farmers and ranchers from a 1997 average of 31 percent to 14
percent. The last tariff reductions occurred in 2008. As
Stanford agricultural economist Scott Rozelle has shown, the
reduction in tariff rates allowed prices for many commodities
in China to converge with world markets. China's average
tariffs and supports for agriculture are now below those of
several other WTO members, including the European Union, Japan,
and South Korea.\72\
The effects of China's trade liberalization are evident in
its trade balance. China's net imports of food have surged from
near zero to more than $40 billion since 2004. As Colin Carter,
professor of Agricultural & Resource Economics at University of
California-Davis, told the Commission, China maintains an
export-oriented horticulture industry, but imports of these
products are outpacing exports.\73\ Although China remains
largely self-sufficient, a small adjustment in its imports has
a disproportionate effect on global markets. Based on
unofficial estimates that include Hong Kong, China is already
the world's top importer of beef and pork.\74\
Nonetheless, China keeps numerous nontariff barriers in
place to restrict U.S. imports. They include excessive
subsidies; government control over import quotas;
discriminatory taxes; and sanitary and phytosanitary
restrictions that are not based on proper scientific analysis.*
These measures have contributed to a very imbalanced food trade
between the United States and China. U.S. soy farmers have
reaped a windfall, accounting for three-fifths of U.S.
agriculture exports to the Mainland in 2012.\75\ China buys up
to seven times more soybeans from the United States than Japan,
the next-largest customer.\76\ Yet other crops have not enjoyed
fair and stable access. With the exception of dried distillers
grains, a corn-based byproduct of U.S. ethanol
production, value-added products based on crops have
also had limited success.
---------------------------------------------------------------------------
* Sanitary and phytosanitary regulations restrict or prohibit
imports and marketing of certain animal species, or products, to
prevent the introduction or spread of pests or diseases that these
animals may be carrying. World Trade Organization, ``Introduction to
the SPS [Sanitary and Phytosanitary] Agreement'' (Geneva, Switzerland:
2013). http: // www.wto.org/english/tratop----e/sps----e/
sps----agreement----cbt----e/c1-s3-p1----e.htm.
Distillers' grains are a cereal byproduct of the
distillation process. There are two main sources of these grains. The
traditional sources were from brewers. More recently, ethanol plants
are a growing source. Corn based distillers grains from the ethanol
industry are commonly sold as a high protein livestock feed that
increases efficiency and lowers the risk of sub-acute acidosis in beef.
U.S.-China Economic and Security Review Commission, Hearing on China's
Agriculture Policy and U.S. Access to China's Market, testimony of
Julius Schaaf, April 25, 2013.
---------------------------------------------------------------------------
Worse still, U.S. consumer foods have entered China at a
slower rate than total trade (see figure 7). China has banned
U.S. beef for a decade. Although China is currently a top
market for U.S. pork, China's pork purchases have been erratic
due to unpredictable food safety-related bans. The U.S. Meat
Export Federation claimed in 2012 that sanitary barriers posed
``the single largest constraint to the expansion of U.S. beef,
pork and lamb exports over the next five years.'' \77\ After
China placed antidumping duties on U.S. broiler chickens in
2010, poultry exports plummeted as well.
Figure 7: Annualized Growth of U.S. Agricultural Exports to China,
2002-2012
Compound Annual Growth Rate (%)
Source: USDA (Washington, DC: Foreign Agricultural Service).
China's nontariff barriers are often protectionist
measures. According to Dr. Gale of the USDA, China's self-
sufficiency policy is based on an exaggerated alarm about the
risks of import reliance. Beijing presumably worries that the
volume of potential Chinese demand is so large that food
imports would outstrip the capability of world markets to
supply the country. There are also strategic concerns that
reliance on imports of any particular commodity will leave
China vulnerable to global price fluctuations and manipulation
of prices by other countries or multinational companies.\78\ In
addition, China's agriculture policy manifests the government's
broader industrial policy. In numerous industries, from
furniture to textiles and steel, China imports raw materials
for value-added processing. That policy frequently entails
heavy subsidies for land, labor, and capital; selective market
barriers for imports and foreign investment; and, increasingly,
support for strategic enterprises and outbound investment in
productive assets overseas.
Sanitary and Phytosanitary Barriers to U.S. Meat Exports
The WTO sets out clear obligations for member states to
only use sanitary and phytosanitary restrictions that do not
``arbitrarily or unjustifiably discriminate between WTO
members' agricultural and food products, and are not disguised
restrictions on international trade.'' \79\ China has applied
numerous food safety-based restrictions on trade that
contravene these principles.
China has persistently banned U.S. meat products following
epidemic outbreaks. In the interest of public health, countries
customarily impose bans on imports if there is a related
epidemic outbreak in the exporting country. China's bans,
however, have frequently exceeded any necessary safety
precautions. The most egregious case is the beef sector. China
joined other countries in closing its market to U.S. beef
imports in 2003 due to one discovered case of BSE (bovine
spongiform encephalopathy, or ``Mad Cow Disease'').* But China
kept its ban in place even after the United States was
classified as a ``controlled risk'' country by the World
Organization of Animal Health in July 2007 and as a ``minimal
risk'' in May 2013.\80\ Likewise, U.S. pork was subject to
unjust bans in April 2009, under the pretext of an H1N1 virus
outbreak, even though the virus is not transmitted by
consumption of food products. China's Ministry of Agriculture
and the General Administration of Quality Supervision,
Inspection and Quarantine only removed the bans in December
2009.\81\
---------------------------------------------------------------------------
* BSE (bovine spongiform encephalopathy) is a progressive
neurological disorder of cattle that results from infection by an
unusual transmissible agent called a ``prion.'' The nature of the
transmissible agent is not well understood. According to the USDA, the
United States has registered four cases of BSE in 2003-2012. The case
that first caused the bans on U.S. beef was recorded in December 23,
2003, in an adult Holstein cow from Washington State. On June 24, 2005,
the USDA announced receipt of final results from the Veterinary
Laboratories Agency in Weybridge, England, which confirmed the first
endemic case of BSE in a 12-year-old Texas cow. On March 15, 2006, the
USDA confirmed BSE in a ten-year-old cow in Alabama. On April 24, 2012,
the USDA confirmed a BSE case in a ten-year-old dairy cow in
California. U.S. Department of Health and Human Services, ``BSE (Bovine
Spongiform Encephalopathy, or Mad Cow Disease)'' (Atlanta, GA).http://
www.cdc.gov/ncidod/dvrd/bse/.
---------------------------------------------------------------------------
Another form of sanitary restrictions relates to residue
levels. It is common for food products to contain some residual
level of antibiotics, pesticides, or other potentially harmful
substances. In order to facilitate trade, most trade partners
agree on allowable maximum residue levels. Residues at low
levels pose minimal health risks, according to international
agreements. But China has adopted a zero-tolerance approach to
ractopamine, a feed ingredient that significantly enhances
yield and efficiency in pork production. The U.S. Food and Drug
Administration (FDA) approved ractopamine as early as December
1999, and it is now approved by 26 countries, including several
countries in Asia.* The Codex Alimentarius Commission
reaffirmed the safety of ractopamine by adopting maximum
residue level standards in July 2012.\82\ Given that codex
determinations serve as a basis for the WTO rules on dispute
resolution, China's zero-tolerance policy is inconsistent with
its WTO commitments. China began blocking shipments from
individual U.S. pork plants after it detected ractopamine in
2006. The issue was raised in 2009-2011 at working group
meetings of the Joint Commission on Commerce and Trade, one of
the main bilateral dialogue mechanisms between the United
States and China. The United States requested that China adopt
an interim maximum residue level for ractopamine. Still, China
refused, and following the 2012 codex ruling did not take any
steps to address its zero-tolerance policy.\83\
---------------------------------------------------------------------------
* As a part of the Codex Alimentarius process, ractopamine
hydrochloride has three times been reviewed by the Joint FAO/WHO Expert
Committee on Food Additives (JECFA), which has recommended safety
standards that align with those within the approved use countries. The
most recent review was for consideration of studies conducted and
submitted by China. The JECFA scientific statement noted that: ``The
Committee concluded that, based on the data provided, including those
from the three breeds of pigs in the studies undertaken by the People's
Republic of China, and corresponding dietary information, the
recommended MRLs [maximum residue levels] are compliant with the ADI
[acceptable daily intake] as regards consumption of pig tissues of
muscle, liver, kidney and fat. The estimated daily intake is
approximately 50% of the upper bound of the ADI for a 60 kg person.''
---------------------------------------------------------------------------
Sanitary restrictions have had a considerable impact on
U.S. livestock producers. The U.S. Meat Export Federation
estimated in 2012 that the decade-old ban on U.S. beef cost
producers as much as $350 million a year.\84\ The blow has been
mitigated somewhat by huge gray markets that transship U.S.
beef products through Hong Kong and other neighboring
jurisdictions into China, to be sold at a markup price to
wealthy diners and shoppers. But that has not made up
for the loss in market share. Australia, a U.S. competitor that
is allowed to export its beef to China, saw its exports rise an
incredible 1,948 percent year-on-year in the first half of
2013.=
---------------------------------------------------------------------------
The presence of this gray market was confirmed by numerous
parties during the Commission's July 2013 trip to China. Beef is
exported legally to Hong Kong, Vietnam, and the Philippines, then
recontainerized and shipped to China. Exporters are allegedly willing
to pay an additional fee for this transshipping. Because U.S. storage
facilities operators in China refuse to harbor illegal imports, the
U.S. beef often ends up stored in Chinese facilities, potentially
making the product less safe. Many restaurants in Shanghai that serve
U.S. beef carry two sets of books in case the authorities come to check
on the beef's country of origin.
= Although Australia is a major beef exporter, it did not send much
beef to China until recently. Australia's traditional markets have been
Japan, South Korea, the Middle East, and the United States. In the
first half of 2013, however, China imported 62,421 tons of Australian
beef, up from 3,048 tons a year earlier. Almost overnight, China became
Australia's third-largest export destination for beef. Presentation by
the U.S. Meat Export Federation (Shanghai, China, July 26, 2013).
---------------------------------------------------------------------------
The barriers have also hurt pork producers, who rely on
fixed rearing and slaughtering cycles and hope for predictable
demand and prices. For instance, China's decision in March 2012
to disallow third-party audits of ractopamine in U.S. pork
suddenly prevented a host of U.S. pork exports from going to
China. According to Mr. Miller, that effectively cut the price
of Iowa's 30 million hogs by $10 per head.\85\ Another factor
that makes compliance with the ractopamine ban difficult is
that it interferes with the complex segmentation of pork
products. As Secretary Northey noted, the United States sends
more pork pieces, such as offal, to China than whole hog
carcasses. By not using ractopamine in the breeding process,
U.S. pork producers incur a higher cost of production for the
whole pig. That puts them at a competitive disadvantage when
they sell muscle cuts and other parts in the U.S. market.\86\
China's sensitivity to food safety for imports is partly a
reaction to the country's internal safety problems. The Chinese
government has argued in its defense that it lacks the
technology to distinguish harmful from less harmful additives.
It has also requested additional research on feed additive
residues in the internal organs of pigs, since those parts of
the animal are more widely consumed in China than the United
States.\87\ Still, as Dr. Gale asserted, China's stringency
results in double standards. Although the Chinese government
outlaws ractopamine, as well as a dangerous alternative,
clenbuterol, countless Chinese pork producers continue to use
these additives to increase feed efficiency. According to Dr.
Gale, ``This brings up an issue of a much tighter enforcement
of standards and regulations for imports than in the domestic
market,'' a violation of basic trade principles.\88\ Mr. Brosch
argued that ``China's strict, and sometimes unsupportable
decisions to impose limitations on U.S. imports are driven
primarily by internal pressures on its government as a result
of past domestic food safety mistakes. In our view, Chinese
health officials are now under a tremendous amount of internal
pressure and scrutiny and want to appear to their domestic
constituents to be increasingly vigilant.''\89\
Antidumping Duties and the Tradeoff between Market Access and Food
Safety
Antidumping (AD) and countervailing duties (CVD) disputes
have been a point of contention in U.S.-China bilateral trade.
The agriculture sector is no exception. China's Ministry of
Commerce (MOFCOM) imposed AD and CVD duties on U.S. chicken
broiler products in August and September 2010, respectively.
The AD duties ranged from 50.3 percent to 53.4 percent for the
U.S. producers who responded to MOFCOM's investigation notice,
while MOFCOM set an ``all others'' rate of 105.4 percent. In
the CVD investigation, MOFCOM imposed countervailing duties
ranging between 4.0 percent and 12.5 percent for the
participating U.S. producers and an ``all others'' rate of 30.3
percent. According to the Office of the U.S. Trade
Representative, American exports to China of broiler products
fell by 80 percent following the application of the duties (see
figure 8).\90\
Figure 8: U.S. Poultry Exports to China, 2002-12
US$ millions
Source: USDA (Washington, DC: Foreign Agricultural Service).
The United States complained to the WTO in September 2011
and was vindicated in August 2013 when a WTO dispute settlement
panel found that China's AD/CVD actions against U.S. broiler
chickens violated its WTO commitments.* The panel supported
nearly all of the U.S. claims, including substantive errors in
MOFCOM's calculations and procedures.\91\ China decided not to
appeal the ruling by the September 10, 2013, deadline.\92\ As a
next step, China will have to demonstrate that it has complied
with the ruling by repealing the duties. At a September 25 WTO
Dispute Settlement Body meeting with Chinese officials, U.S.
officials said they hoped the decision would force Beijing to
fundamentally re-evaluate how it proceeds in AD and CVD
investigations.\93\
---------------------------------------------------------------------------
* Broiler products include most chicken products, with the
exception of live chickens and a few other products such as cooked and
canned chicken.
---------------------------------------------------------------------------
Although the WTO decision marked a victory, the AD/CVD
actions against broiler products are emblematic of a broader
conflict in bilateral trade that is unresolved. China's actions
against broiler products coincided with an escalation in other
trade disputes. Beijing threatened to impose the duties on
chicken in September 2009, weeks after the United States
applied a 35 percent tariff on Chinese-made tires.
Within a week of the U.S.'s announcement that it would
challenge the tariffs on broiler products, China applied
dumping duties on U.S. automobiles and auto parts.= The United
States also angered China by filing an AD case against Chinese
honey in 2000. China's share of U.S. honey imports was around
30 percent when the AD case was initiated, and today that
market share is near zero.\94\
---------------------------------------------------------------------------
On September 11, 2009, the president imposed additional
duties on imports of certain passenger vehicle and light truck tires
from China for a period of three years in order to remedy the market
disruption caused by those imports, as determined by the U.S.
International Trade Commission (USITC). China challenged the imposition
of the duties, alleging that the USITC's determination regarding market
disruption and the level and duration of the additional duties were
inconsistent with the Protocol of Accession and the General Agreement
on Tariffs and Trade (GATT) 1994. A WTO panel later rejected all of
China's claims, and the Appellate Body rejected all of China's claims
on appeal. Office of the U.S. Trade Representative, ``United States
Prevails in WTO Dispute about Chinese Tire Imports'' (Washington, DC:
USTR Press Release, September 2011). http: // www.ustr.gov/about-us/
press-office/press-releases/2011/september/united-states-
prevails-wto-dispute-about-chinese.
= This is now a separate WTO complaint by the United States. See
WTO, ``China--Certain Measures Affecting the Automobile and Automobile-
Parts Industries'' (Geneva, Switzerland: Dispute DS450). http://
www.wto.org/english/tratop----e/dispute----/cases-_-e/ds450-_-e.htm.
---------------------------------------------------------------------------
Furthermore, the broiler duties were implemented less than
two years after Congress passed the DeLauro Amendment, a piece
of legislation introduced by Representative Rosa DeLauro (D-
OH), chair of the House Appropriations agriculture
subcommittee, to the 2008 Farm Bill. The amendment prohibited
funding the USDA Food Safety Inspection Service (FSIS)
inspection of processed poultry imports from China. China soon
challenged the ban in the WTO. The U.S. Trade Representative
and the USDA worked with Congress to soften the language of the
DeLauro Amendment in the fiscal year 2010 agriculture
appropriations bill, opening the door to funding inspections of
Chinese-processed poultry if certain conditions could be met by
the USDA. * \95\ Nonetheless, China did not withdraw its WTO
complaint and a year later won the case.\96\ The United States
subsequently repealed the amendment. Some U.S. agriculture
officials and advocates argue that it left a negative legacy
for market access negotiations, particularly in regard to
China's bans on U.S. beef. Owing to the USDA's dual functions
as a trade negotiator and food safety inspector, certain
Chinese officials apparently believe that the agency is capable
of influencing U.S. food safety legislation in return for
greater market access in China.\97\
---------------------------------------------------------------------------
* According to a spokesperson at the time, Rep. DeLauro agreed to
the amended bill in part because it requires that the USDA: (1)
increase inspections and audits of Chinese poultry processing plants
once they are certified; (2) make public the list of eligible plants
and the outcomes of audits of those plants; and (3) not rush to an
equivalency determination for the safety of China's poultry slaughter
operations, which are to be subject to a separate approval process from
poultry processing. Inside U.S.-China Trade, ``Compromise Reached on
Poultry Ban, Could End U.S.-China WTO Dispute,'' September 30, 2009,
via Factiva database.
---------------------------------------------------------------------------
U.S. interest groups are divided about the merits of
curbing Chinese food imports through legislation such as the
DeLauro Amendment. For Patty Lovera of Food & Water Watch and
other food safety advocates, U.S. food consumers need to be
protected from China's unsafe production and weak regulation.
According to this argument, China does not deserve an
``equivalence determination,'' under which its food safety
process would be deemed equivalent to the USDA's standards. The
USDA audits prospective meat processing plants in China and
approves those that meet its standards but then only visits
them on a periodic basis for auditing purposes.\98\ In the
United States, a USDA inspector is always present at each
plant. For food safety advocates, these regulatory procedures
do not sufficiently guarantee the safety of Chinese poultry
imports (See Food Safety section below for more discussion of
food safety inspection.)\99\
On the other hand, poultry industry advocates argue that
the U.S. government has committed a grave error in interfering
with bilateral poultry trade. U.S. agribusinesses have invested
heavily in Chinese chicken production and processing--both to
feed Chinese consumers and as a future export platform to U.S.
consumers--and they have been working to get USDA approval for
Chinese poultry exports to the United States. These advocates
argue that USDA-FSIS approvals and equivalency procedures of
Chinese exporting plants are sufficiently stringent, as the
United States currently permits poultry imports from only three
other countries--Costa Rica, Canada, and Chile. The DeLauro
Amendment, they argue, refuses USDA-FSIS the funding to even do
its job. By targeting China, it also violates the U.S.'s WTO
commitments and sets a bad example for unilateral action
against a single trade partner in the WTO system. They further
assert that very little processed poultry will be imported, as
China has no commercial advantage in this market segment.\100\
On September 5, the USDA-FSIS reaffirmed the equivalence of
China's food safety inspection system for processed poultry,
which was originally established in 2006. That will enable
China to certify plants to export processed poultry products to
the United States. The raw poultry used for these products must
originate in the United States and Canada, as the USDA-FSIS has
yet to provide equivalency status for slaughtered poultry in
China. Nevertheless, the decision lays the foundation for
negotiating future exports of processed poultry using Chinese-
origin birds.\101\
State Trading and Domestic Supports
Another means by which China has restricted the flow of
trade in agriculture is by requiring state trading * and
providing domestic supports. These policies have done
particular damage to U.S. exports of land-intensive crops and
meat products. State trading impacts the allocation of tariff-
rate quotas. Tariff-rate quotas function as a way of protecting
a market from excessive imports and, at the same time, provide
a means of liberalizing trade and breaking up monopolies by
dividing up the quota among different traders and passing on
unfilled quotas. Following WTO accession, China's trading
monopoly China National Cereals, Oils and Foodstuffs Corp.
agreed to reduce its exclusive rights by allocating some quotas
to other traders in a transparent manner.\102\
---------------------------------------------------------------------------
* State trading enterprises are defined as governmental and
nongovernmental enterprises, including marketing boards, which deal
with goods for export and/or import. Article XVII of the General
Agreement on Tariffs and Trade (GATT) 1994 is the principal article
dealing with state trading enterprises (referred to as ``STEs'') and
their operations. It sets out that such enterprises--in their purchases
or sales involving either imports or exports--are to act in accordance
with the general principles of nondiscrimination and that commercial
considerations only are to guide their decisions on imports and
exports. It also instructs that members are to notify their state
trading enterprises to the WTO annually. World Trade Organization
(Geneva, Switzerland). http://www.wto.org/english/tratop----e/
statra----e/statra----e.htm.
---------------------------------------------------------------------------
However, China has been reluctant to comply with these
commit- ments. In 2002, the National Development
and Reform Commission, the Chinese agency in charge of
implementing the regulations, refused to provide details on
amounts and recipients of allocations. It also reserved a
significant portion of tariff-rate quotas for the processing
and reexport trade instead of the import-competing sector. By
2004, tariff-rate quotas improved after considerable U.S.
pressure through the Joint Commission on Commerce and Trade
negotiations. Nevertheless, state-owned enterprises still
dominate bulk commodity trading, accounting for an estimated 90
percent of the wheat quota, 60 percent of the corn quota, 50
percent of the rice quota, 70 percent of the sugar quota, and
33 percent of the cotton quota. One way that China achieves
this is by maintaining stringent licensing requirements to
limit the pool of eligible nonstate firms.\103\
Further, Beijing has leveraged its extensive state control
over commodity import decisions as a tool of economic
diplomacy. In December 2003 and February 2012, then Premier Wen
Jiabao and then Vice President Xi Jinping negotiated landmark
soybean acquisition deals during state visits to the United
States. In both cases, the acquisitions were timed as a ``feel-
good'' deliverable to offset U.S. concerns about the bilateral
trade deficit.\104\
While China has agreed to minimize subsidies to meet its
WTO commitments, it has found ways to support farmers and
processors by subverting the rules. One example is its
discriminatory use of the value-added tax (VAT) levied on
industry. China signed on to the Article III of the General
Agreement on Tariffs and Trade (GATT), which explicitly states,
``WTO members shall not be subject, directly or indirectly, to
internal taxes or internal charges of any kind in excess of
those applied directly or indirectly to [a] like domestic
product.'' In fact, China has not complied with this
commitment. In 2009, USDA-funded research found that China
imposes a 13 or 17 percent VAT on food and agriculture imports,
while China's own farmers and meat producers use a complex
rebate system in order to pay almost no VAT at all.* Stated
Veronica Nigh of the American Farm Bureau Federation: ``The
effect of many of China's VAT rebate adjustments is to make
larger quantities of primary and intermediate products in a
particular sector available domestically at lower prices than
the rest of the world, giving China's downstream producers the
finished products using these inputs a competitive advantage
over foreign downstream producers.'' \105\
---------------------------------------------------------------------------
* Slaughterhouses and food processors, for example, are given major
deductions from the nominal VAT, as they are permitted to ``impute'' a
VAT paid at prior stages of production. The differential VAT rates
charged for domestic producers and imports thus constitute a clear
violation of Article III of the General Agreement on Tariffs and Trade
(GATT) 1994. U.S. Trade Representative, Hearing on China's Compliance
with World Trade Organization Commitments, written testimony of
National Pork Producers Council, September 24, 2012; and U.S. Grains
Council, National Trade Estimates Report Submission (Washington, DC:
October 12, 2012), p. 17.
---------------------------------------------------------------------------
The VAT tax is one of the reasons why value-added
production has been transferred from the United States to
China. Soybeans, the top U.S. agricultural export, are shipped
primarily in bulk form instead of processed feed. According to
Iowa Secretary of Agriculture William Northey, China's domestic
soybean crushing industry has expanded rapidly, to the extent
that it now has 40 to 50 percent overcapacity.\106\ Foreign
investment has contributed to this capacity buildup--foreign
agribusiness firms, including Archer Daniels Midland, Bunge,
and Cargill, own about 70 percent of China's soybean crushing
industry.\107\ Some of this production is also ending up on
world markets: statistics compiled by the United Nations (UN)
Food and Agriculture Organization show that China's exports of
feed, meal, and gluten increased by 63 percent a year in 2001-
2011, while U.S. exports declined by 8 percent per annum over
the same period. U.S. market share in this trade category
declined from 79 percent to 43 percent in 2001-2011.\108\
The Office of the U.S Trade Representative affirms that
agriculture is just one of several sectors in which China has
used discriminatory taxation to gain a competitive edge:
China's economic planners attempt to manage the export
of many primary, intermediate and downstream products
by raising or lowering the value-added tax (VAT) rebate
. . . these border tax practices have caused tremendous
disruption, uncertainty and unfairness in the global
markets for the affected products--particularly when
these practices operate to incentivize the export of
downstream products for
which China is a leading world producer or exporter .\10
9\
China has also been able to provide billions of dollars in
agriculture subsidies through a series of loopholes. One such
loophole is how China defines the ``value of production.'' Farm
support under the WTO's de minimis provision is measured as a
share of total production value. Agricultural production,
according to the Chinese government's questionable
statistics,\110\ has been expanding at a significant 12 percent
a year. Thus, subsidies can be very large in nominal terms but
appear small relative to production.\111\
A related form of farm support is China's procurement and
stockpiling of commodities to subsidize domestic producers and
offset market prices.\112\ For nearly all major staple crops,
China holds an outsized share of global stockpiles (see figure
9).\113\ China has adopted a particularly aggressive
stockpiling policy toward three of the largest U.S. exports to
China: soybeans, corn, and cotton. The stockpiles are derived
not only from imports but also domestic production. In 2008, in
view of the rapid price increases and fluctuations of soybeans
on the global market, the National Development and Reform
Commission began to procure domestic soy at above the world
market price, thus establishing a reserve stockpile and also
boosting the income of its soy farmers. China announced last
year that it would stockpile soybeans for a fifth year
running.\114\ China's latest No. 1 Document, released in
January 2013, lays out policies to raise the minimum purchase
prices for wheat and rice; stockpile corn, soybeans, and other
crops; and adjust export and import duties as necessary to
achieve food (grain) security.\115\
Figure 9: China, U.S., and Japan's Share of Surplus Stockpiles of Key
Commodities, 2012
Share (%)
Note: Stockpiles are calculated based on what a country produces,
consumes, and trades. The surplus left over at the end of each year is
the stockpile.
Source: Food and Agriculture Organization, Agricultural Market
Information System (Rome, Italy: Agriculture Market Information System
Secretariat). http://statistics.amis-outlook.org/data/index.html#.
According to testimony from Mark Lange, the president of
the U.S. National Cotton Council, China's subsidies to its
domestic cotton industry are having a negative impact on U.S.
cotton exports, which account for 14 percent of U.S.
agricultural exports to China. China in recent years began
procuring cotton from its domestic producers for a rate far
above world market prices. That has actually hurt China's
textile mills, which are forced to buy expensive cotton and are
barred by import licensing quotas from increasing imports of
cheaper cotton from the United States. The mills are thus
turning to manmade synthetic fibers, in turn boosting China's
chemical industry. This policy has affected U.S. cotton exports
to China, as well as introducing considerable uncertainty into
the industry, as cotton prices could plummet once China
releases its stockpiles onto the world market.\116\
In the pork sector, the U.S. National Pork Producers
Council recently estimated that U.S. pork exports to China
would increase by 50 percent if China eliminated its domestic
pork subsidies. Pork subsidies rose substantially following an
outbreak of swine disease that reduced China's pork production
in 2007 and 2008. In January 2009, the Chinese government
introduced a price support scheme for pork called the
``National Price Alert and Subsidy Program.'' The program is
based on the ratio between China's live hog and corn prices:
when the hog-corn price ratio falls below a certain range--
either because pork is too cheap or corn too expensive--the
government procures pork from the domestic market at generous
prices to support pork farmers. Related policies include hog
and pork stockpiling; a sow insurance program; and a cash
subsidy scheme for large-scale breeding farms.\117\
China's Agribusiness Development and Regulation of Foreign Investment
Restricted Access for U.S. Firms in China's Agriculture Sector
The United States has helped China in diverse ways to
develop its agriculture sector. During its July 2013 trip, the
Commission met with representatives of Archer Daniels Midland
Company, Cargill China, Preferred Freezer Services, and other
U.S. companies that have built state-of-the-art production,
processing and storage facilities on the Mainland. Cargill
China and OSI Group have recently established vertically
integrated poultry breeding facilities by consolidating land
from local farmers. U.S. companies hire thousands of employees
in China and, in some cases, finance training at their
facilities in the United States.\118\ U.S. food retailers, led
by Yum! Brands, Inc. and McDonald's Corp., have transferred
best practices in the food service industry. These private
sector efforts are being reinforced by technical assistance
programs administered by U.S. government agencies and U.S.
universities. The United States and China have launched more
than 500 science and technology exchange programs since they
established the working group on agricultural science and
technology cooperation in 1980, with around 3,000 experts
involved. In 2011, the two sides held the fourth meeting of the
China-U.S. Joint Commission on Agriculture, which developed
guidance to the two working groups on agricultural sciences and
biotechnology.*
---------------------------------------------------------------------------
* The Commission, on its July 2013 China trip, met with faculty
from the Northwest Agriculture and Forestry University, one of China's
top agronomics faculties based in Shaanxi Province, who discussed their
partnerships with the University of California-Davis and other U.S.
universities. Xinhua China Economic Information Service, ``China to
Deepen Agricultural Cooperation with U.S.,'' February 12, 2012, via
Factiva database.
---------------------------------------------------------------------------
However, in spite of these supportive efforts, U.S.
companies have not been granted fair market access in China. A
pervasive problem is regulatory uncertainty, in the form of
state-run media campaigns targeting foreign brands; stricter
oversight than for domestic companies; and corrupt practices by
officials at the local level. U.S. companies are
required to enter into joint ventures with Chinese companies as
a condition for investing in certain sectors.= Although this
requirement per se does not violate China's WTO commitments, it
often benefits China's state-owned enterprises. For example,
Coca-Cola's joint venture partner in China is a subsidiary of
China National Cereals, Oils and Foodstuffs Corp., the same
conglomerate that dominates China's state trading of
commodities.\119\ And although restrictions on foreign
investment have been relaxed, major investments still require
approval from the Chinese government. In 2009, for instance,
China invoked its new antitrust law to prevent Coca-Cola from
purchasing the juice maker Huiyuan Juice.\120\ Several sectors
of China's economy are in fact off-limits to foreign companies;
in the agriculture sector, foreign companies are prohibited
from buying land; investing in the production of transgenic
plant seeds; and constructing and operating large-scale
wholesale markets for agricultural products.\121\
---------------------------------------------------------------------------
A more optimistic assessment of these problems, voiced by
some businesses, is that foreign companies serve as models for the rest
of industry and are chosen by Chinese officials to experiment with new
policies, such as environmental and food safety standards. U.S.
companies, meetings with Commissioners, Shanghai, China, July 25-26,
2013.
= The relevant rules for joint ventures are laid out in the
Catalogue of Industries for Guiding Foreign Investment that was first
introduced by the State Council in 1995 and last revised in 2011. The
catalogue comprises over 450 industries. In nearly 100 of those
industries, foreign investment is subject to ownership restrictions.
About half of those restrictions require foreign investors to form
joint ventures--equity, cooperative, or contractual--with Chinese
partners. State Council, ``Waishang touzi chanye zhidao mulu (2011 nian
xiuding)'' (Catalogue of Industries for Guiding Foreign Investment--
2011 Revisions) (Beijing, China: 2011). http://www.gov.cn/flfg/2011-12/
29/content_2033089.htm.
---------------------------------------------------------------------------
U.S. companies are also anxious about guarding their
intellectual property in China. Barbara Glenn, vice president
of Science and Regulatory Affairs at CropLife America, told the
Commission that U.S. agrochemical and seed companies in China
have encountered counterfeit goods as well as unauthorized
misappropriation of trade secrets that are used to produce
infringing products. These practices discourage U.S.
agrochemical firms from investing in research and development
in China and from deploying their most cutting-edge products
there.\122\
Further, U.S. developers of biotechnology are concerned
about China's regulatory approval process. For the majority of
these companies, which invest heavily in genetically modified
seeds, China has become central to their business model,
because their customers produce crops for export to China. At
present, China only begins the approval process for a foreign
biotechnology event when that event has already been approved
in the exporting country. Ideally, both countries would conduct
the approvals at the same time in order to expedite the
process. This system of ``asynchronous approvals'' has become a
pressing concern for U.S. agribusinesses.\123\ Julius Schaaf,
vice chairman of the U.S. Grains Council, told the Commission:
Among the most important factors affecting the near
term evolution of U.S. exports of corn is the
regulatory treatment of biotechnology. . . . As the
importance of biotech crops continues to increase
globally, potential disruptions due to inconsistent and
sometimes unpredictable national treatment have become
a recurring concern. With regard to China, the
asynchronous approval process for biotech events is of
particular importance.\124\
China's Agribusinesses and Outbound Investment
In parallel to restricting market access for foreign
agribusinesses, Beijing is fostering its own ``state
champions'' to consolidate the agriculture sector. China's
leading state-owned agribusiness, China National Cereals, Oils
and Foodstuffs Corp., has extended its business from the grain
trade to diverse activities along the value chain, from grain
crushing to livestock production and beverage making.
Meanwhile, quasi-private firms are expanding, especially in the
livestock industry. These include Shuanghui Group, China's
largest pork producer. The company began as a meat processing
plant under a municipal government in Henan Province, in the
interior of China. As recently as 2004, Shuanghui Group was
taken over by a municipal branch of the government's State-
Owned Asset Supervision and Administration Commission, an
agency charged with restructuring state-owned enterprises. In
2006, the government divested its interest in Shuanghui Group,
selling to a consortium led by Goldman Sachs and CDH, a Chinese
private equity fund. Nonetheless, Shuanghui's current chairman,
Wan Long, has stayed in charge throughout this
``privatization'' process. He is a longtime member of China's
Communist Party and National People's Congress. Through a
management buyout in 2010, he has been able to exercise
majority control over the company's shares and voting
rights.\125\ The Chinese private equity firm New Horizon
Capital--cofounded by former premier Wen Jiabao's son Wen
Yunsong--is a minority shareholder of Shuanghui. * \126\
---------------------------------------------------------------------------
* New Horizon is a private equity group cofounded by Wen Yunsong,
the only son of former premier Wen Jiabao. According to the Financial
Times, Wen Yunsong ``has been an active participant in Chinese
investment since earning an MBA at Kellogg management school at
Northwestern University in the US.'' New Horizon's first fund was
incorporated in the Cayman Islands in 2005 with $100 million. A primary
contributor to that first fund was Temasek, Singapore's sovereign
wealth fund. New Horizon closed its second fund in May 2007 with $500
million. The Financial Times reported in January 2010 that New Horizon
was close to raising $1 billion from foreign investors for a fund that
will invest in Chinese enterprises on the Mainland. Among the
contributors to the latest fund are U.S. and European institutions. In
addition to Shuanghui, New Horizon's equity investments include
Xinjiang Goldwind, China's largest wind power equipment maker, and
Zoomlion, China's second-largest construction machinery maker. Jamil
Anderlini, ``China Premier's Son Nears $1bn Target for Fund,''
Financial Times, January 27, 2010, via Factiva database; U.S. Senate
Committee on Agriculture, Nutrition, and Forestry, Hearing on
Smithfield and Beyond: Examining Foreign Purchases of American Food
Companies, testimony of Usha Haley, 113th Cong., 2nd sess., July 10,
2013.
---------------------------------------------------------------------------
China's agribusinesses have pursued outbound investment in
several countries and sectors (see figure 10). According to Dr.
Gale, government policy influences these outbound investments.
Of note is what Dr. Gale refers to as the ``two markets, two
resources'' strategy, which ``calls for control of overseas
farm production, processing and logistics by Chinese companies
for commodities that cannot be supplied domestically.'' The
premise is that supply chain control will give Chinese
companies a greater cost and price advantage in global markets.
The ``two markets, two resources'' strategy is manifest in a
plan, issued by the National Development and Reform Commission,
that designates companies for overseas ventures. The two
flagship companies chosen to shore up vegetable oil supplies,
for instance, are Chongqing Grain Group and Beidahuang, an
agribusiness company created by the Heilongjiang Province state
farm system. These two companies have plans to invest in
soybean and rapeseed production, processing, and logistics in
Brazil, Russia, and Canada. Reportedly, Chongqing Grain Group
has already begun importing soybeans from its Brazil project.
Similarly, China National Cereals, Oils and Foodstuffs Corp.
and other state-owned enterprises are to invest in soybean,
cassava, rubber, and sugar projects. The strategy is financed
by earmarked loans from state banks and public offerings in
equity markets.\127\ Tax breaks have supported agribusiness
growth as well: Article 27 of China's Enterprise Income Tax Law
provides that income generated from agriculture, forestry,
husbandry, or fisheries may be exempted from the tax.\128\
Figure 10: Outbound Investments by Chinese Firms in the Food Sector, 2008-2012
--------------------------------------------------------------------------------------------------------------------------------------------------------
Investment Land
Year Month Investor ($ Subsector Country Type Share Partner/Target Acqui-
millions) Size sition
--------------------------------------------------------------------------------------------------------------------------------------------------------
2012 Dec. Yili $210 Dairy New Equity 100% Oceania Dairy No
Industrial Zealand
--------------------------------------------------------------------------------------------------------------------------------------------------------
2012 Nov. Shanghai $730 Sugar Aus- Green- -- -- Yes
Zhongfu tralia field
--------------------------------------------------------------------------------------------------------------------------------------------------------
2012 Sept. Synutra $120 Dairy France Joint -- Sodiaal No
venture
--------------------------------------------------------------------------------------------------------------------------------------------------------
2012 Aug. Complant$170 Sugar Jamaica Equity 100% State-owned Yes
sugar plants
--------------------------------------------------------------------------------------------------------------------------------------------------------
2012 May Bright Foods $1,940 ConsBritain Equity 60% Weetabix No
foods
--------------------------------------------------------------------------------------------------------------------------------------------------------
2012 Apr. Shanghai $170 Dairy New Equity 100% Crafar Yesms
Pengxin Zealand
--------------------------------------------------------------------------------------------------------------------------------------------------------
2011 Aug. Bright Foods $390 ConsumeAus- Equity 75% Manassen Foods No
foods tralia
--------------------------------------------------------------------------------------------------------------------------------------------------------
2011 July COFCO $140 Sugar Aus- Equity 99% Tully Sugar Yes
tralia
--------------------------------------------------------------------------------------------------------------------------------------------------------
2011 June Heilongjiang $1,510 Soybeans Argen- Joint -- Cresud Yes
Beidahuang tina venture
Nongken
--------------------------------------------------------------------------------------------------------------------------------------------------------
2011 March Chongq$1,410 Soybeans Brazil Green- -- -- Yes
Grain field
--------------------------------------------------------------------------------------------------------------------------------------------------------
2010 Oct. Sinochem $1,440 Agro- Israel Equity 60% Makhteshim-Agan No
chemicals
--------------------------------------------------------------------------------------------------------------------------------------------------------
2009 July CIC $370 ConsBritain Equity 1% Diageo No
foods
--------------------------------------------------------------------------------------------------------------------------------------------------------
2008 June China Na$140al Pork USA Equity 5% Smithfield No
Cereals, Foods
Oils and
Foodstuffs
--------------------------------------------------------------------------------------------------------------------------------------------------------
Sources: ``China Global Investment Tracker'' (Washington, DC: Heritage Foundation, July 2013). http://www.heritage.org/research/projects/china-global-
investment-tracker-interactive-map; various media sources.
In the United States, China's outbound investments came
into focus in June 2013, when Shuanghui International Holdings
Limited, a subsidiary of Shuanghui Group, proposed to acquire
Smithfield Foods Inc., the largest U.S. pork producer. The
deal, valued at $7.1 billion, is the largest-ever acquisition
of a U.S. company by a Chinese company. It raises several
critical issues. First, Smithfield is the market leader in the
U.S. pork industry, and thus acts as a strategic node in the
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U.S. pork supply chain (see table 2).
Table 2: Top-Ten Pork Producers in the United States by Sows and Slaughtering Capacity
----------------------------------------------------------------------------------------------------------------
Sows (2012) Daily slaughter
------------------------ capacity (2009)
------------------------
Sows Market Slaughter Market
share capacity share
----------------------------------------------------------------------------------------------------------------
1 Smithfield 862,000 28.4% 1 Smithfield 126,300 28.4%
2 Triumph 378,500 12.5% 2 Tyson 74,550 16.8%
3 Seaboard 217,000 7.1% 3 Swift 47,000 10.6%
4 Maschhoffs 196,000 6.4% 4 Excel 38,500 8.7%
5 Prestage Farms 165,000 5.4% 5 Hormel 37,000 8.3%
6 Iowa Select Farms 160,000 5.3% 6 Seaboard 19,200 4.3%
7 Pipestone System 145,000 4.8% 7 Excel 19,000 4.3%
8 Cargill 136,000 4.5% 8 Indiana Packing Co. 16,500 3.7%
9 Carthage System 103,500 3.4% 9 Hatfield 10,600 2.4%
10 AVMC Management Services 82,000 2.7% 10 J.H. Routh 4,200 0.9%
Other 593,800 19.5% Other 52,075 11.7%
TOTAL 3,038,800 TOTAL 444,925
----------------------------------------------------------------------------------------------------------------
Source: Top U.S. Pork Powerhouses, 2012. http://www.agriculture.com/uploads/assets/promo/external/siteimages/
PP2012.pdf.
Second, the deal is not guaranteed to improve overall
market access for U.S. pork in China. China is unlikely to
abandon its policy of self-sufficient meat production. A more
likely result is a closed market of intracompany trade between
Shuanghui and Smithfield, combined with U.S. soybean and corn
imports to feed China's hogs. Given Smithfield's massive
output, it could supply the bulk of China's limited imports of
U.S. pork. Indeed, Smithfield has developed a special
relationship with Shuanghui over several years. At its plant in
North Carolina, the largest of its kind in the world,
Smithfield already switched over to ractopamine-free pork
production at Shuanghui's request, prior to the proposed
acquisition.\129\ Meanwhile, other pork plants in the United
States could still find it tough to export to China, either
because the costs of complying with ractopamine restrictions
are too high or because they do not enjoy the privileges of a
firm owned by a Chinese parent company.
Third, even if China does import more U.S. pork, U.S. meat
slaughterers and processors could lose out. Under the 12th
Five-Year Plan (2011-2015), China has begun to consolidate and
industrialize its meat industry. It is shutting down backyard
farms in favor of large, vertically integrated operations.
Although technically in private hands, Shuanghui is crucial to
the government's efforts to enact this policy. The problem for
Shuanghui is that it has built large industrial facilities to
slaughter and process pork but lacks the hogs to fill them.
Without direct control over hog farms, it sources meat from
smaller producers, which leads to erratic quality and output.
Importing pig carcasses from Smithfield appears to be an
expedient solution. Shuanghui might use Smithfield mainly as a
supplier of hog carcasses. Usha Haley told the U.S. Senate
Committee on Agriculture, Nutrition, and Forestry:
Extrapolating from what has occurred in steel, paper,
glass, auto parts and solar, the United States will
become an exporter of the commodity of pork to China,
and an importer of higher-value-added processed foods
from China. . . . Although U.S. exports to China of
pork will rise, U.S. imports of processed foods from
China will rise even faster, contributing to the trade
deficit and loss of manufacturing capacity. . . . U.S.
companies would be unable to compete domestically and
in exports against a Shuanghui-Smithfield that does not
pursue profits but is heavily subsidized and aims for
industry domination.\130\
Fourth, while Smithfield could become a ``raw material''
supplier to Shuanghui, it would also transfer substantial
intellectual property and branding power to its Chinese parent.
Technology transfer * is a salient trend in China's pork
industry. Along with consolidation and capacity expansion, the
Chinese government is seeking better technologies to improve
the productivity of its livestock. According to Delta Farm
Press, a respected agriculture publication in the United
States, China is ``capitalizing on decades of cutting-edge U.S.
agricultural research.'' \131\ Chinese producers are especially
looking to forge uniform herds based on the most efficient
breeds, like Duroc, Yorkshire, and Landrace.\132\ From 2002 to
2007, China imported a total of 13,000 head of swine; from 2008
to 2011, live swine imports totaled 39,000 head--15,000 in 2011
alone.\133\ In 2002-2012, China increased its share of U.S.
live swine exports from 5 percent to 51 percent.\134\
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* Owing to its vertically integrated operations, Smithfield has
played a pioneering role in modernizing breeding techniques for U.S.
hog farms, competing head-on with dedicated genetics and breeding
companies. The Smithfield Lean Generation Pork \TM\ Program has been
among the nation's leading fresh pork programs, with dozens of branded
items in its product line. Already in the 1990s, Smithfield acquired
long-term rights for the NPD hog, a breeding line developed by National
Pig Development Co., a British firm. In 2000, it bought out the U.S.
branch of NPD, forming an in-house unit to undertake research and
development. This intellectual property will be transferred to
Shuanghui.
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Finally, an irony not lost on opponents of the Smithfield
acquisition is that, if the situation were reversed, China's
laws on foreign acquisitions would allow the government to
block the sale on economic and commercial grounds rather than
just national security, as is the case with the U.S. laws.
Stated Dr. Haley: ``As the Chinese government views pork-
processing as a strategically important industry, the country
is unlikely to open this market to U.S. companies.'' \135\
Shuanghui and Smithfield submitted their proposed
transaction for approval to the Committee on Foreign Investment
in the United States (CFIUS) in June. On September 6, the
companies received clearance from CFIUS.\136\ The shareholders
voted September 24 to approve the sale. The transaction is
expected to become final toward the end of 2013.\137\
Food Safety: China's Penetration of the U.S. Food Chain
The Safety of U.S. Food Imports from China
China's WTO accession was primarily envisaged as an
opportunity for U.S. exporters. But U.S. food imports from
China have surged as well, part of a greater reliance on
imported food by U.S. consumers. Food imports from
China tripled to 4.1 billion pounds in 2001-2012 and have
reached a high level of penetration for specific products (see
figure 11). The majority of imports consists of consumer-
oriented products. For these products, the United States
accumulated a trade deficit of $5 billion with China in 2008-
2012. About a third of U.S. food imports from China are fresh,
frozen, and processed fish and seafood products. Another 41
percent is comprised of fruits and vegetables, products that
often compete directly with U.S. producers.\138\
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The U.S. Government Accountability Office (GAO) reports
that from 2000 through 2011, the percentage of food consumed in the
United States that was imported rose from 9 percent to over 16 percent,
and food imports increased by an average of 10 percent each year for
seven years. ``According to the U.S. Department of Agriculture's
Economic Research Service, the food groups with the highest share of
imports are fresh fish and shellfish (85 percent in 2009) and fruits
and nuts (38 percent in 2009).'' U.S.-China Economic and Security
Review Commission, Hearing on China's Agriculture Policy and U.S.
Access to China's Market, testimony of Patty Lovera, April 25, 2013.
Figure 11: Imports from China as Share of U.S. Consumption
Four-Year Average, 2008-2011, share (%)
Sources: USDA, GATS [General Agreement on Trade in Services]
Database (Washington, DC: Foreign Agricultural Service); USDA,
Vegetable and Melon Yearbook 2011 and Fruit and Tree Nut Outlook
(Washington, DC: Economic Research Service, 2012); and U.S. National
Fisheries Institute, ``Top 10 Consumed Seafoods,'' 2012, via U.S.-China
Economic and Security Review Commission, Hearing on China's Agriculture
Policy and U.S. Access to China's Market, testimony of Patty Lovera,
April 25, 2013.
Imports from China also comprise a host of processed foods
and food ingredients whose provenance may be less obvious to
U.S. consumers. Food ingredients include xylitol, used as a
sweetener in candy; ascorbic acid, a preservative; and vitamin
ingredients, like folic acid and thiamine, frequently added to
food products. Processed food imports, in turn, include vitamin
C, candy, condiments, pet food, and pasta and baked goods, as
well as food supplements and even gel capsules and nonactive
pill binders for pharmaceuticals.\139\
For the United States, these imports from China present
significant food safety risks. Over the past decade, China's
major trade partners have repeatedly banned its food shipments
on the basis of food safety. The earliest actions centered on
seafood--the European Union and the FDA temporarily blocked
imports of shrimp, crayfish, and crabmeat from China in 2002-
2004 after discovering high residue levels of chloramphenicol,
a broad spectrum antibiotic drug used to treat life-threatening
infections in humans.\140\ China's food product safety garnered
wider attention in 2007, when excessive antibiotic and
pesticide residues led several countries, including South
Korea, Japan, and the European Union, to impose renewed
bans.\141\ The most imminent threat to the United States at the
time was pet food from China that contained a harmful
industrial solvent, melamine. The FDA received reports of
17,000 pet illnesses, including 4,000 dog and cat deaths,
believed to be the result of melamine contamination in imported
Chinese gluten used to make pet food. Sixty million packages of
melamine-contaminated pet food were recalled. That did not
prevent a portion of melamine-contaminated products from ending
up in other U.S. food products; there were reports that 56,000
hogs ate melamine-tainted pet food and were processed into
pork, which was then sold at supermarkets.\142\ The melamine
threat did not end there. In the fall of 2008, the FDA also
recalled candy made by U.S. companies in China due to concerns
of melamine contamination in Chinese milk.\143\ The FDA in June
2012 and June 2013 twice extended bans on milk products from
China, which included chocolate products.\144\
------------------------------------------------------------------------
------------------------------------------------------------------------
China's Organic Food Exports to the United States
China has become a supplier of organic foods to the U.S. market.
According to the USDA's National Organic Program, from 1995 to 2006, the
value of organic food exported from China rose from $300,000 to $350
million annually. By 2010, 649 operations in China were certified by the
USDA as meeting U.S. organic standards.\145\ Ironically, these imports
now include organic soybeans. Because organic livestock producers in the
United States cannot use the genetically modified soybeans harvested at
home, they are turning to China's nongenetically modified beans
instead.\146\
Organic foods are generally characterized by methods of farming that
do not involve synthetic inputs such as chemical fertilizers. In China
bureaucratic infighting has led to the emergence of two competing
standards for organic food. The Ministry of Agriculture has promoted a
less rigorous ``green food'' standard since the early 1990s, which
comprises foods that have very low levels of chemical residues. The
Environment Ministry, in turn, adheres to a more rigorous ``organic
food'' standard, which requires that food products contain no chemical
residues at all. To encourage organic food exports, China has lobbied to
make these standards equivalent with those of developed country markets
like the United States, the European Union, and Japan. At present,
however, neither standard has achieved international recognition.\147\
The USDA issues its own approvals for organic food produced in China.
It does so by accrediting private, third-party certifiers. Once these
certifiers approve a Chinese production facility, that facility's
products are ``USDA certified'' and can be sourced by Whole Foods and
other organic food retailers in the United States. Some experts assert
that the USDA has exhibited a lack of due diligence in issuing certain
approvals. USDA officials three years ago visited China to conduct an
audit of four of the ten companies it had accredited as organic food
certifiers. The officials reported that conditions ``pose challenging
oversight duties andresponsibilitiesfor certifyingagentsoperatingin
China.''They
------------------------------------------------------------------------
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------------------------------------------------------------------------
China's Organic Food Exports to the United States--Continued
discovered, for instance, that a certifier had used Chinese government
employees to inspect state-controlled farms, suggesting a direct
conflict of interest among different actors in China's government.\148\
------------------------------------------------------------------------
---------------------------------------------------------------------------
Inadequate Food Safety Regulation in China
Current regulation of food entering the United States from
China is insufficient. First of all, the Chinese government's
own food safety regulation is inadequate. Multiple agencies
oversee the food safety regulation process, including the
Ministry of Health; the Ministry of Agriculture; the Ministry
of Commerce; and importantly, the General Administration of
Quality Supervision, Inspection, and Quarantine, which has
separate jurisdiction over customs inspections. In the United
States, there is no separate agency for customs. The various
Chinese agencies also have central and local branches, forming
a fragmented and decentralized system of regulation.\149\
The Chinese government in 2009 introduced a comprehensive
Food Safety Law to establish a modern framework for food safety
regulation. The law was partially successful in handing more
oversight power to the Ministry of Health and creating an
intraministerial working group. This regulatory consolidation
was reinforced in March 2013, when the government created a new
China Food and Drug Administration, which took on certain
responsibilities from the State Food and Drug Administration;
the Ministry of Agriculture; the State Council's Food Safety
Committee; and the General Administration of Quality
Supervision, Inspection, and Quarantine.\150\ The 2009 law also
made progress in specifying guidelines for hazard analysis and
risk management, in order to track food safety ``from farm to
plate.'' \151\ During its trip to China, the Commission met
with officials from the China Food and Drug Administration to
learn more about their activities.\152\
However, it is uncertain whether these reforms will make a
substantial difference. The consolidation of agencies has
stopped short of full integration. For instance, farm-level
production and slaughter is still overseen by the Ministry of
Agriculture.* Further, the China Food and Drug Administration
has just a few hundred staff at the central government level in
charge of overseeing tens of thousands of less-capable
inspectors in local agencies.\153\ Due to extreme fragmentation
of production--with an estimated 450,000 companies in food-
processing alone--traceability of food products remains a stiff
task.\154\
---------------------------------------------------------------------------
* The China Food and Drug Administration will apparently handle the
safety of food production as well as distribution, in contrast to its
predecessor, the State Food and Drug Administration, which supposedly
handled only safety in the food service industry. In spite of this
regulatory integration, the General Administration of Quality
Supervision, Inspection, and Quarantine Department remains responsible
for customs inspections, while the Ministry of Agriculture remains in
charge of overseeing ``primary'' production, including livestock
slaughter. Brady Sidwell (vice president, corporate development, OSI
Group), e-mail to Commission staff, July 31, 2013.
---------------------------------------------------------------------------
Academic research has shown that the 2009 Food Safety Law
has done little so far to hold producers and officials
accountable. According to John Balzano of Yale Law School,
Chinese consumers still have difficulty filing coordinated
lawsuits against food companies, and the courts rarely
investigate public officials.\155\ Other experts have argued
that illegal food production occurs in China because local
officials are responsible for both economic growth and food
safety and, in many cases, prioritize the former.\156\ As a
result, safe and high-quality food production is not
consistently rewarded, while unsafe and low-quality production
is not consistently punished.\157\ The Chinese government has
resorted instead to public displays of enforcing food safety
rules, inspecting food facilities, and punishing people
connected with tainted food, especially in high-profile cases.
In July 2007, for example, the former head of the State Food
and Drug Administration was executed on conviction of receiving
$850,000 in bribes.\158\ The melamine scandal in 2009 led the
authorities to close down half the country's dairies.\159\ Two
years later, a concerted crackdown on food safety violations
resulted in 2,000 arrests and 4,900 businesses being closed.
These actions were widely reported in the state media.\160\
Problems with U.S. Food Safety Inspection
In the absence of effective regulation by the Chinese
government, U.S. consumers depend on U.S. food safety
inspectors to do their jobs. And yet, there are numerous
problems with U.S. food regulation. The system is fragmented,
underfunded, and heavily reliant on third-party verification--
structural flaws documented through extensive congressional
hearings and government reports.\161\ The FDA and the USDA
divide up food safety inspection by product group, with most
seafood, horticulture, and processed foods coming under the
jurisdiction of the FDA. Patty Lovera of Food & Water Watch
testified: ``The USDA is in charge of meat and poultry. The FDA
is in charge of basically everything else. We spend a lot of
time in this context thinking about the FDA because those are
the products that are coming in at this point from China.''
\162\
Relative to its broad oversight role, the FDA's
capabilities are limited. At the Commission's 2008 hearing on
food safety in the seafood industry, the FDA's director of the
Center for Food Safety and Applied Nutrition acknowledged that
the surge of Chinese food imports has ``outstretched and
outgrown the regulatory system for imports in the [United
States].'' \163\ Based on expert testimony received by the
Commission in 2008 and 2013, the FDA inspects less than 2
percent of the food that passes through U.S. borders.\164\
Inspection rates in Japan and the European Union are several
times higher.\165\ Nor does the agency always act forcefully
when it discovers a problem; shipments are turned away by the
FDA but not destroyed, so that products can potentially reenter
the country through another port, a phenomenon known as ``port-
shopping.'' \166\
According to Ms. Lovera, weak regulation at the border is
compounded in China's case by a lack of cooperation between the
two countries' authorities. During the melamine-tainted pet
food crisis in 2007, for example, it took the FDA one month to
identify and communicate with its regulatory counterparts in
China.\167\ A USDA Economic Research Service report from 2009
asserts that the Chinese government guards the food safety data
it collects, making it difficult to impartially evaluate
China's food safety performance.\168\ Kelli A. Giannattasio,
the FDA's deputy country director in China, told the Commission
that some progress has been made since then to widen channels
of communication. Nonetheless, China's balkanized system of
regulation, in which food production and distribution is
overseen by different agencies at the central and local levels,
has made it difficult to identify the right counterparties once
a risk is identified.\169\
The FDA has made substantial efforts to improve its border
inspections. These were outlined by the FDA's associate
director for Global Operations and Policy, Steven M. Solomon,
at a May 2013 hearing of the Congressional-Executive Commission
on China. Mr. Solomon pointed out that the 2011 Food Safety
Modernization Act, the most wide-reaching reform of U.S. food
safety laws in 70 years, lays the foundation for a more
prevention-based approach to regulating imports. He also noted
that, while the FDA does not ``physically inspect all imports''
that enter the country, it does ``electronically screen all
imports using an automated risk-based system to determine if
shipments meet identified criteria for physical examination or
other review.'' To enhance its ability to target high-risk
products, the agency recently developed the Predictive Risk-
based Evaluation for Dynamic Import Compliance Targeting
application, a screening system that uses intelligence from
many sources to provide the entry reviewer with risk scores on
every import line.\170\
The FDA is also trying to involve U.S. importers more
directly in food safety oversight. Under the Foreign Supplier
Verification Program, introduced in August, food importers in
the United States must assess which types of safety risks are
posed by the food they are importing and obtain documentation
from the exporter that show how those risks are being
mitigated. Importers will be required to conduct or obtain
results of annual on-site audits of the exporter's facility.
One loophole in the new regulations is that they do not apply
to aquaculture products, one of the U.S.'s top imports from
China. Aquaculture products are subject only to the less
stringent Hazard Analysis and Critical Control Points program,
under which importers are not required to retain detailed
documentation to show how their foreign suppliers are
controlling risks.\171\
To supplement the efforts to improve food regulation at
home, U.S. food safety inspectors have attempted to step up
their on-the-ground presence in China. According to Ms. Lovera,
the FDA visited just 46 food firms on the Mainland in 2001-
2008--less than six a year.\172\ Since then, the agency has
devoted more resources to its food safety oversight in China.
Initial budget increases were enacted in 2009. The fiscal year
2013 Continuing Resolution added $10 million to the FDA's base
to fund the addition of seven food and nine drug inspectors
permanently posted in China.\173\ Under a memorandum of
agreement that the U.S. Department of Health and Human Services
signed with China in December 2007, the Chinese government
permitted more FDA inspectors to enter the country and allowed
the FDA to open offices in Beijing, Shanghai, and
Guangzhou.\174\ Commission witness William Westman, who served
as agricultural attache to the U.S. embassy in Beijing in the
mid-2000s, noted that 11 FDA attaches were installed at the
various U.S. consulates by the end of his tenure.\175\
According to the FDA's fiscal-year 2013 appropriations report,
its inspections in China increased from 16 in 2009 to 55 in
2011, a tangible improvement.\176\
Still, U.S. food safety regulation in China has many
shortcomings. Even with additional inspectors on the Mainland,
the agency may find it difficult to monitor China's vast and
fragmented food processing industry.\177\ Regulatory barriers
imposed by Chinese authorities have added to the problem.
Stated Ms. Giannattasio:
Currently, our main challenge stems from delays in
issuance of visas for additional FDA staff in China. .
. . To date, China's Ministry of Foreign Affairs has
not issued diplomatic visas that would enable the
deployment of these inspectors to China on a full-time
basis. In order to continue its inspection efforts,
FDA's China Office is working with FDA's Office of
Regulatory Affairs to deploy inspectors on temporary
assignment to carry out the inspections FDA needs to do
in China.\178\
Another impediment is China's reluctance to grant access to
plants. Under the memorandum of agreement signed with the
United States in 2007, the Chinese government promises FDA
inspectors better access to Chinese facilities but reserves the
right to control their movements and access.\179\ These
restrictions appear to still be in place--during August 2012
visits to Chinese processing plants that export pet treats to
the United States, U.S. inspectors were not permitted to
collect samples for independent analysis.\180\
The United States and China are working together to improve
food safety. Examples of collaboration include:
LThe USDA and the FDA, along with major U.S.
companies, participate in the China State Council's annual
China International Food Safety and Quality Conference and
Expo, inaugurated in 2007.\181\
LA working group on economically motivated
adulteration meets on a regular basis by video, linking
Washington-based experts with the China Food and Drug
Administration's key decision-makers.\182\
LIn November 2012 and May 2013, the FDA and
China's General Administration of Quality Supervision,
Inspection and Quarantine held workshops for members of Chinese
industry to address concerns regarding aquaculture practices
for fish farms. These workshops have significantly enhanced the
FDA's understanding of China's oversight system for aquaculture
products and have provided Chinese industry with a clearer
understanding of the FDA's requirements and practices.\183\
LThe China-U.S. Plan of Strategic Cooperation in
Agriculture (2012-2017), signed in February 2012 by the USDA
and China's Ministry of Agriculture, states that the two
countries will develop ``mutually beneficial international
standards on food safety''; ensure implementation of science-
based laws, regulations, policies, and standards; ensure
transparency of the regulatory decision-making process and food
safety initiatives; and improve institutions and working
mechanisms of emergency response. To this end, both sides
``propose to more actively engage'' in bilateral and
international meetings.\184\
Implications for the United States
China is now the top market for U.S. agricultural exports,
but not everyone in the U.S. farming community is benefitting
equally. China's imports from the United States have been
concentrated in bulk commodities, a trade pattern quite
different from U.S. agricultural exports to the rest of the
world. U.S. soybean exporters have gained disproportionately,
to the extent that they have become quite dependent on the
Chinese market. A problem for all bulk commodity exporters to
China is that nation's policy of using taxes and subsidies, in
combination with stockpiling and state trading, to control
commodity trade flows. Therefore, much of the value-added
processing of commodities is taking place in China rather than
in the United States, which is hurting U.S. manufacturers and
contributing to U.S. unemployment.
Among consumer foods, U.S. meat products have the most to
gain in China. Chinese consumers are shifting to a higher-
priced, protein-heavy diet, while China's domestic livestock
industry is reaching its capacity limits. The United States
enjoys a comparative advantage in resources, productivity, and
quality for meat production. And yet, U.S. beef and pork
producers have been affected by China's heavy subsidization of
domestic production and, even more, by its stringent sanitary
barriers. Many sanitary measures appear designed either to
protect domestic producers or to shift the blame for domestic
food safety lapses onto foreign products. A complicating factor
for the United States is that China is not alone in abusing
health and safety measures. Some of the U.S.'s best beef export
markets have been slow to lift BSE-related restrictions. Japan,
South Korea, and Taiwan will only accept U.S. beef from animals
less than 30 months of age.\185\ The European Union and Taiwan
ban imports of U.S. pork treated with ractopamine.\186\ By the
same token, the intensifying competition from other
agricultural exporters, such as Australia, Brazil, and
Argentina, allows China to hedge its import strategy in ways
that can damage U.S. interests.\187\
A key challenge for the United States is to treat China as
a major market rather than a developing country in need of
development assistance. The United States and China are
engaging in extensive bilateral cooperation in agriculture. The
USDA has signed a Plan of Strategic Cooperation with its
Chinese counterparts on agricultural science, trade, and
education. U.S. universities and companies are also actively
engaged in China. But this outreach is not always conducive to
improving market access for U.S. exporters and foreign
investors, who view China as a strategic market for their
business.
Another challenge is to reconcile different interests in
U.S. trade policy. In regional terms, Iowa has profited the
most from trade with China, given its extensive production of
crops to feed China's livestock. The Iowa state government has
been very proactive in fostering bilateral diplomacy.
Conversely, specialty crop growers in the Pacific Northwest,
beef producers in the Central Plains, and cotton and poultry
producers in the South have been more critical of the evolving
relationship. There is also a need to recognize the actors in
China that might be for and against trade with the United
States. For example, the Ministry of Agriculture, which
prioritizes the interests of Chinese farmers, and the Ministry
of Commerce, which seeks to implement China's WTO commitments,
do not always share common interests.
The case of poultry illustrates the tradeoffs of
negotiating bilateral trade deals. U.S. poultry producers have
been the unfortunate targets of Chinese retaliation in a
broader trade dispute involving auto parts and tires. U.S.
government efforts to support domestic producers and protect
consumers in the food sector have not always achieved to their
intended effects and, in some cases, have worked at cross
purposes. Food safety advocates argue that allowing China to
export processed poultry to the United States is too high a
price to pay for greasing the wheels of bilateral trade deals.
WTO accession has allowed China to export vast amounts of
fruits, vegetables, fish, and processed foods to the United
States, causing health scares and overstretching the U.S. food
inspection regime. In the future, the U.S. government will have
to strike a balance between expanding a rules-based trading
regime that favors exporters and taking action to block Chinese
imports if safety cannot be assured. It will also need to
enhance the capacities of the USDA and the FDA to screen food
imports at the border and on the ground in China. That will
require better cooperation from the Chinese authorities--the
U.S. State Department last October formally notified the
Chinese Ministry of Foreign Affairs about obtaining visas for
additional FDA inspectors, but as of September 2013, the visas
had not been granted.\188\
The proposed acquisition of Smithfield by a Chinese pork
producer, Shuanghui, was approved by CFIUS and by Smithfield's
shareholders in September. The case illustrates that Chinese
companies can make major acquisitions of U.S. companies in the
agriculture sector without being blocked on national security
grounds. At the same time, the case elicits important questions
about U.S. policy toward foreign investors from China.
Smithfield is the largest pork producer in the United States
and hence a strategic supplier of food to U.S. consumers. While
Shuanghui is a quasi-private company, it maintains strategic
ties to the Chinese government. The case also has a bearing on
intellectual property protection, net economic benefits, and
reciprocal market access.
Conclusions
LFor the past three years, China has been the largest
export market for U.S. agricultural goods. However, trade is
far from free, and enormous opportunities are being withheld.
China's WTO accession has not been as productive to the United
States as initially expected. In contrast to U.S. agricultural
exports to the rest of the world, most U.S. exports to China
are bulk commodities, particularly raw soybeans that supply
China's outsized livestock sector. Conversely, processed
commodities, meat products, consumer foods, and other higher
value-added products have not kept pace with the overall growth
in bilateral trade.
LSince the 1980s, China has developed into the world's
largest agricultural economy, producing a fifth of the world's
grains, a quarter of its meat, and half of its vegetables. But
demand in China is beginning to outstrip supply. As more people
move to cities and earn higher incomes, China's population is
demanding safer food and a more diverse, protein-rich diet at
an affordable cost. The United States is well-positioned to
meet that demand. U.S. farmers enjoy a comparative advantage in
resources, productivity, and quality, particularly in meat
production.
LChina's agriculture policy favors domestic production
over imports. China maintains ambitious self-sufficiency
targets that are unsustainable and unjustifiable in terms of
food security. This policy is now being challenged by the
decline in China's farm labor surplus, deteriorating land and
resource endowments, and fragmented producer and land use
systems. A related problem is that efforts to modernize
agriculture conflict with rural welfare aims. Millions of rural
migrants continue to rely on farmland and smallholder
agriculture for insurance in the absence of a functioning
welfare state.
LChina has failed to fully perform its obligations
under the WTO. It has erected a series of nontariff barriers
that include state trading; excessive domestic subsidies and
stockpiling of commodities; discriminatory taxes; uncalled-for
antidumping duties; and slow approvals of biotechnology
applications for U.S. crops. Damaging to U.S. interests as well
are sanitary and phytosanitary restrictions, especially BSE-
based bans on beef and zero tolerance for ractopamine in pork.
Although China has significantly lowered its tariffs and
increased its agricultural imports since accession, numerous
trade restrictions remain in place.
LU.S. companies, universities, and government agencies
are helping China to improve the quantity and quality of its
food output. In a sign of deepening bilateral ties, the United
States and China signed the first U.S.-China Plan of Strategic
Cooperation in Agriculture (2012-2017) in February 2012, and in
March of that year the largest-ever U.S. agricultural trade
mission visited China. However, U.S. companies operating in
China are hamstrung by regulatory uncertainty, restricted
market access, and weak intellectual property enforcement.
LChina is fostering globally competitive
agribusinesses, in the process becoming an active acquirer of
agricultural assets overseas. In June 2013, China's largest
pork producer, Shuanghui, proposed a $7.1 billion acquisition
of Smithfield, the leading pork producer in the United States.
While the deal has been approved by CFIUS and Smithfield's
shareholders, it raises critical issues regarding net economic
benefits, intellectual property, reciprocal market access, and
the treatment of quasi-private Chinese companies that maintain
links to the Chinese government.
LChina accounts for a large share of the fruits,
vegetables, fish, and processed foods that Americans consume,
but the United States has little assurance that the food
imports coming into the United States from China are safe.
China's own food safety regulation is still ineffective, in
spite of recent efforts to consolidate agencies and improve
legislation. U.S. consumers rely on U.S. food safety inspectors
to do their jobs, but U.S. regulation is also fragmented and
underfunded. U.S. regulators have increased their presence
within China but have struggled to obtain work visas and to
gain access to food production facilities. Although the United
States does not permit raw meat imports from China, the USDA
has granted equivalence status to Chinese poultry processors,
which will permit them to process poultry raised in the United
States and Canada and ship it to the United States.
ENDNOTES FOR SECTION 4
1. USDA Foreign Agricultural Service Global Agriculture Trade
System online. http://www.fas.usda.gov/gats/default.aspx.
2. U.S. Census Bureau, Foreign Trade: Trade in Goods with China
(Washington, DC: U.S. Department of Commerce). http://www.census.gov/
foreign-trade/balance/c5700.html.
3. USDA Foreign Agricultural Service, ``Text: Glickman Says
China's WTO Entry to Boost U.S. Exports'' (Washington, DC: February 16,
2000). http: // www.fas.org/news/china/2000/000216-prc-usia3.htm;
USDA Foreign Agricultural Service Global Agriculture Trade System
online. http://www.fas.usda.gov/gats/default.aspx.
4. Field to Market homepage. http: // www.field-to-market.org/
report/national-2/
PNT----NatReport----Socioeconomic----Agri-Contribution-To-Natl-And-St
ate-GDP-.-pdf.
5. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of William Northey and David Miller, April 25, 2013.
6. USDA, ``Land Values 2012 Summary'' (Washington, DC: August
2012), p. 5.
7. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of William Northey, April 25, 2013.
8. USDA, ``U.S., China Sign Plan of Strategic Cooperation in
Agriculture'' (Washington, DC: Office of Communications, Release No.
0057.12, February 16, 2012). http: // www.usda.gov/wps/portal/
usda/usda-media-fb?-content-id= 2012 / 02 / 0057.
xml-&-printable-=-true-&-con-tent-id-only-=-true.
9. Western Farm Press, ``USDA Leads Largest Ever Trade Mission,''
March 2, 2012. http: // western-farm-press.com / government / usda -
leads - largest - ever - agricultural -trade-mission-china.
10. U.S.-China Economic and Security Review Commission, Hearing on
Chinese Seafood: Safety and Trade Issues, April 24-25, 2008.
11. The Pacific Institute, ``The World's Water: Volume 7 Data''
(Oakland, CA: 20--10). http://www.worldwater--.org/data.html; Mindi
Schneider, ``Feeding China's Pigs: Implications for the Environment,
China's Smallholder Farms, and Food Security'' (Minneapolis, MN:
Institute for Agriculture and Trade Policy, May 2011), p. 1.
12. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Fred Gale, April 25, 2013.
13. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Kevin Brosch, April 25, 2013.
14. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Dermot Hayes, April 25, 2013.
15. Presentation by the U.S. Meat Export Federation (Shanghai,
China: July 26, 2013).
16. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Dermot Hayes, April 25, 2013.
17. Cheng Hongming, ``A Sociological Study of Food Crime in
China,'' British Journal of Criminology 52 (2012): 254-273; Don Lee,
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18. Food Sentry.org, Preliminary Analysis of International Food
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Gale and Jean C. Buzby, ``Imports from China and Food Safety Issues''
(Washington, DC: USDA, Economic Research Service, Economic Information
Bulletin 52, July 2009); and U.S.-China Economic and Security Review
Commission, Hearing on China's Agriculture Policy and U.S. Access to
China's Market, testimony of Patty Lovera, April 25, 2013.
19. Wu Linhai, Xu Lingling, and Gao Jian, ``The Acceptability of
Certified Traceable Food among Chinese Consumers,'' British Food
Journal 113:4 (2011): 519-21.
20. Shi Yan et al., ``Safe Food, Green Food, Good Food: Chinese
Community Supported Agriculture and the Rising Middle Class,''
International Journal of Agricultural Sustainability 9:4 (2011): 551-
52; Richard Sanders, ``A Market Road to Sustainable Agriculture?
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Development and Change 37:1 (2006): 207-10.
21. Yang Ling Qinling Mountains Modern Agriculture Co., Ltd.,
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22. National Bureau of Statistics, via CEIC database.
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Wire, April 9, 2013, via Factiva database; Shenzhen Daily, ``Baby
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24. Jeff Correa (director of International Marketing, Pear Bureau
Northwest), discussions with Commission staff, Washington, DC, June
2013.
25. Peter Foster, ``Top 10 Chinese Food Scandals,'' Telegraph
(United Kingdom), April 27, 2011; U.S.-China Economic and Security
Review Commission, Hearing on China's Agriculture Policy and U.S.
Access to China's Market, testimony of Patty Lovera, April 25, 2013;
and New York Times, ``Rat Meat Sold as Lamb Highlights Food Fears in
China,'' May 3, 2013.
26. U.S.-China Economic and Security Review Commission, Hearing on
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of Colin Carter, April 25, 2013.
27. Food and Agriculture Organization, FAOStat Database (Rome,
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Food Additive,'' Christian Science Monitor, July 20, 2007. http://
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and Policies'' (Center for Chinese Agricultural Studies, January 2010);
Zhou Zhangyue, ``Achieving Food Security in China: Past Three Decades
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nomic Review 2:3 (20--10): 25--1-----75; and World Bank, ``World Bank
China Projects and Programs'' (Washington, DC: 2013). http://
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all?sector----_exact=Agricultural+extension+and+research&qterm=rural+dev
elop--ment&
srt---=---board-approval-date-&-order---=---asc-&-lang-_-exact---=---Eng
lish.
29. Julian M. Alston and Philip G. Parsley, ``Developing-Country
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(Washington, DC: International Food Policy Research Institute, 2006),
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%20Peoples-% 20-Republic-% 20-of -_-3-20-2013.pdf.
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34. USDA, ``Livestock and Poultry: World Markets and Trade,''
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36. Cattle and swine figures here refer to beginning stocks. USDA,
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67. U.S.-China Economic and Security Review Commission, Hearing on
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68. Scott Rozelle, ``Overview of China's Agricultural Development
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87. U.S.-China Economic and Security Review Commission, Hearing on
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99. U.S.-China Economic and Security Review Commission, Hearing on
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of Patty Lovera, April 25, 2013.
100. U.S.-China Economic and Security Review Commission, Hearing on
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of Kevin Brosch, April 25, 2013.
101. U.S.-China Economic and Security Review Commission, Hearing on
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Commission, Hearing on China's Agriculture Policy and U.S. Access to
China's Market, testimony of Veronica Nigh, April 25, 2013.
112. U.S.-China Economic and Security Review Commission, Hearing on
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116. U.S.-China Economic and Security Review Commission, Hearing on
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120. Forbes, ``What Coca Cola Did Wrong, and Right, in China,''
March 24, 2009. http:/--/www.forbes.com/2009/03--/24/--coca---cola---
china---leadership-citizenship---huiyuan.html.
121. State Council, ``Waishang touzi chanye zhidao mulu (2011 nian
xiuding)'' (Catalogue of Industries for Guiding Foreign Investment--
2011 Revisions) (Beijing, China: 20--1--1). http:/--/www--.gov.cn/
--flfg--/20--1--1---------1--2/29--/--content----_-2033089.htm; Baker
McKenzie, ``Client Alert: Revisions to the Catalogue for Guiding
Foreign Investment in Industry 2011'' (Beijing, China: January 2012),
pp. 3-4. http://www.bakermckenzie.com/files/Uploads/Documents/ China % 20 Update % 20 2012 /
al _ china _ foreign-investment-catalogue-_-jan12.pdf.
122. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Barbara Glenn, April 25, 2013.
123. Office of the U.S. Trade Representative, 2012 USTR Report to
Congress on China's WTO Compliance (Washington, DC: December 2012), pp.
88-89; U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Veronica Nigh, April 25, 2013; and U.S.-China Economic and Security
Review Commission, Hearing on China's Agriculture Policy and U.S.
Access to China's Market, testimony of Julius Schaaf, April 25, 2013.
http://www.ndrc.gov.cn/zcfb/zcfbl/2011ling/W020111229379511927834.pdf.
124. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Julius Schaaf, April 25, 2013.
125. Henan Shuanghui Investment & Development Company Limited, 2010
Annual Report (Luohe, Henan, China, 2011), p. 9. http://
disclosure.szse.cn/m/finalpage/2012-03-02/60612313.PDF ; Shuanghui
Group, ``Fazhan Licheng'' (Development History) (Luohe, Henan, China:
date?). http://www.shuanghui.net/html/category/about/fzlc; Shuanghui
Group. ``Linghangren Jieshao'' (Leadership Introduction) (Luohe, Henan,
China: 2013). http://www.shuanghui.net/html/category/about/lhrjs;
Shuanghui Group, ``Fazhan Licheng'' (Development History) (Luohe,
Henan, China: 2013). http://www.shuanghui.net/html/category/about/fzlc;
Henan Shuanghui Investment & Development Company Limited, 2004 Annual
Report (Luohe, Henan, China: 2005), p. 6. http://www.shuanghui.net/
shfz/pdf/nb2006.pdf ; Henan Shuanghui Investment & Development Company
Limited, 2006 Annual Report (Luohe, Henan, China: 2007), p. 4; http://
www.shuanghui.net/shfz/pdf/nb2006.pdf and Reuters, ``Goldman Sachs
Gets Nod for China Shuanghui Purchase,'' December 12, 2006. http://
news.oneindia-.-in / 2006 / 12 / 12 / goldman - sachs - gets - nod -
for - china - shuanghui-purchase-1165-905-597-.html.
126. U.S. Senate Committee on Agriculture, Nutrition, and Forestry,
Hearing on Smithfield and Beyond: Examining Foreign Purchases of
American Food Companies, testimony of Usha Haley, 113th Cong., 2nd
sess., July 10, 2013.
127. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Fred Gale, April 25, 2013.
128. U.S. Senate Committee on Agriculture, Nutrition, and Forestry,
Hearing on Smithfield and Beyond: Examining Foreign Purchases of
American Food Companies, testimony of Usha Haley, 113th Cong., 2nd
sess., July 10, 2013.
129. Financial Times, ``Shuanghui Hopes $7bn Deal Will Allay
Produce Fears,'' May 29, 2013, via Factiva Database.
130. U.S. Senate Committee on Agriculture, Nutrition, and Forestry,
Hearing on Smithfield and Beyond: Examining Foreign Purchases of
American Food Companies, testimony of Usha Haley, 113th Cong., 2nd
sess., July 10, 2013.
131. Darrell Ray and Harwood D. Schaffer, ``China's Agricultural
Future: Adopt U.S. Developed Technologies,'' Delta Farm Press, May 11,
2012, via Factiva database.
132. Mindi Schneider, ``Feeding China's Pigs: Implications for the
Environment, China's Smallholder Farms, and Food Security''
(Minneapolis, MN: Institute for Agriculture and Trade Policy, May
2011), p. 18.
133. Darrell Ray and Harwood D. Schaffer, ``China's Agricultural
Future: Adopt U.S. Developed Technologies,'' Delta Farm Press, May 11,
2012, via Factiva database.
134. U.S. International Trade Commission, Interactive Tariff and
Trade Dataweb (Washington, DC). http://hts.usitc.gov/. HTS code 0103.
135. U.S. Senate Committee on Agriculture, Nutrition, and Forestry,
Hearing on Smithfield and Beyond: Examining Foreign Purchases of
American Food Companies, testimony of Usha Haley, 113th Cong., 2nd
sess., July 10, 2013.
136. Inside U.S.-China Trade, ``Shuanghui International and
Smithfield Foods Receive CFIUS Clearance'' (Smithfield Foods and
Shuanghui International joint press release). http://
chinatradeextra.com.
137. Nasdaq, ``Smithfield Shareholders Approve Merger--Analyst
Blog,'' September 25, 2013. http: // www.nasdaq.com/article/
smithfield-shareholders-approve-merger-analyst-blog-cm280385.
138. U.S.-China Economic and Security Review Commission, Hearing on
the Impact of U.S.-China Trade and Investment on Pacific Northwest
Industries, testimony of Christian Schlect, January 13, 2005; USDA
Foreign Agricultural Service Global Agriculture Trade System online.
http://www.fas.usda.gov/gats/.
139. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Patty Lovera, April 25, 2013.
140. US Fed News, ``FDA Seizes Adulterated Crabmeat in Louisiana,''
July 7, 2004, via Factiva database; Reuters, ``US Steps Up Seafood
Testing for Banned Antibiotic,'' June 14, 2002, via Factiva database.
141. Associated Press, ``China's Food Safety Affects Us All; Pet
Food Crisis Reveals the Global Implications of Its Lax Regulations,''
April 13, 2007, via Factiva database; Andrew Walker, ``Red Alert Sounds
on Contaminated Food from China's Archaic Plot System,'' Sunday
Independent (Ireland), April 29, 2007, via Factiva database.
142. David Barboza, ``An Export Boom Suddenly Facing a Quality
Crisis,'' New York Times, May 18, 2007; USDA, ``Joint Update: FDA/USDA
Update on Tainted Animal Feed'' (Washington, DC: USDA, Release No.
0121.07, March 2, 2007); FDA, ``Hog Meat Safe to Eat, Testing Shows''
(Washington, DC: April 23, 2007). http://www.fda.gov/ForConsumers/
ConsumerUpdates/ucm061945.htm.
143. Lisa Abraham, ``Halloween Confections from China on Shelves,''
Akron (Ohio) Beacon Journal, October 22, 2008, via Factiva database.
144. The Times of India, ``FDA Warns of Action Against Sale of
Chinese Milk Products,'' July 6, 2012, via Factiva database; The Times
of India, ``FDA Extends Ban of Chinese Milk Products,'' June 30, 2013,
via Factiva database.
145. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Patty Lovera, April 25, 2013.
146. Mark Peters, ``A Gap in Organic Food Chain,'' Wall Street
Journal, July 15, 2013, p. A3.
147. Richard Sanders, ``A Market Road to Sustainable Agriculture?
Ecological Agriculture, Green Food and Organic Agriculture in China,''
Development and Change 37:1 (2006): 201-224; Mark Godfrey, ``BRICs and
Beyond: Organic Food's Identity Problem in China,'' Just-Food, February
9, 2012. http://www.just-food.com/analysis/organic-foods-identity-
problem-in-china----id118210.aspx.
148. Liu Chenglin, ``Is `USDA Organic' a Seal of Deceit?: The
Pitfalls of USDA Certified Organics Produced in the United States,
China, and Beyond,'' Stanford Journal of International Law 47 (2011):
333-78.
149. APCO Worldwide, ``Will China's Food Safety Law Make China's
Food Safer?'' (Washington, DC: April 2009). http://
www.apcoworldwide.com/content/contactus.aspx; Fred Gale and Jean C.
Buzby, ``Imports from China and Food Safety Issues'' (Washington, DC:
USDA, Economic Research Service, Economic Information Bulletin 52, July
2009).
150. Brady Sidwell (vice president, corporate development, OSI
Group), e-mail to Commission staff, July 31, 2013.
151. APCO Worldwide, ``Will China's Food Safety Law Make China's
Food Safer?'' (Washington, DC: April 2009). http://
www.apcoworldwide.com/content/contactus.aspx.
152. China Food and Drug Administration, meeting with
Commissioners, Beijing, China, July 22, 2013.
153. China Food and Drug Administration, meeting with
Commissioners, Beijing, China, July 22, 2013.
154. Don Lee, ``Chinese Food Makers Learn to Swallow Scrutiny,
Controls,'' Los Angeles Times, September 24, 2007. http://
articles.latimes.com/2007/sep/24/business/fi-chinafood24 ; Fred Gale
and Jean C. Buzby, ``Imports from China and Food Safety Issues''
(Washington, DC: USDA, Economic Research Service, Economic Information
Bulletin 52, July 2009).
155. John Balzano, ``China's Food Safety Law: Administrative
Innovation and Institutional Design in Comparative Perspective,''
Asian-Pacific Law & Policy Journal 13:2 (2012): 23-80.
156. Cheng Hongming, ``A Sociological Study of Food Crime in
China,'' British Journal of Criminology 52 (2012): 254-273.
157. Patrick Woodall (Research Director and Senior Policy Advocate,
Food & Water Watch), telephone interview with Commission staff, October
8, 2013; Cheng Hongming, ``A Sociological Study of Food Crime in
China,'' British Journal of Criminology 52 (2012): 254-273.
158. Kirsty Barnes, ``China Carries Out Execution on Corrupt Drug
Official,'' Outsourcing Pharma, July 10, 2007. http://www.outsourcing-
pharma.com/Commercial -Services/China-carries-out-execution-on-corrupt-
drug-official.
159. Peter Foster, ``Top 10 Chinese Food Scandals,'' Telegraph
(United Kingdom), April 27, 2011.
160. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Patty Lovera, April 25, 2013.
161. U.S. Government Accountability Office, ``Food Safety: FDA Can
Better Oversee Food Imports by Assessing and Leveraging Other
Countries' Oversight Resources'' (Washington, DC: September 28, 2012).
http://www.gao.gov/products/GAO-12-933.
162. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Patty Lovera, April 25, 2013.
163. For all the above, see U.S.-China Economic and Security Review
Commission, Hearing on Chinese Seafood: Safety and Trade Issues
(Washington, DC: April 24, 2008).
164. U.S.-China Economic and Security Review Commission, Hearing on
Chinese Seafood: Safety and Trade Issues, testimony of Patrick Woodall,
April 25, 2008; U.S.-China Economic and Security Review Commission,
Hearing on China's Agriculture Policy and U.S. Access to China's
Market, testimony of Patty Lovera, April 25, 2013.
165. U.S.-China Economic and Security Review Commission, 2008
Annual Report to Congress (Washington, DC: U.S. Government Printing
Office, 2011), p. 92.
166. U.S.-China Economic and Security Review Commission, Hearing on
Chinese Seafood: Safety and Trade Issues, testimony of Kim Chauvin,
April 25, 2008.
167. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Patty Lovera, April 25, 2013.
168. Fred Gale and Jean C. Buzby, ``Imports from China and Food
Safety Issues (Washington, DC: USDA Economic Research Service, July
2009), p. 4.
169. Kelli A. Giannattasio (deputy country director, U.S. Food and
Drug Administration, People's Republic of China), e-mail to Commission
staff, Washington, DC, September 6, 2013.
170. Congressional-Executive Commission on China, Food and Drug
Safety, Public Health, and the Environment in China, testimony of
Steven M. Solomon, May 22, 2013.
171. Inside U.S.-China Trade, ``FDA Proposes New Requirements for
Importers to Show Food Is Safe,'' August 14, 2013.
172. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Patty Lovera, April 25, 2013.
173. Kelli A. Giannattasio (deputy country director, U.S. Food and
Drug Administration, People's Republic of China), e-mail to Commission
staff, Washington, DC, September 6, 2013.
174. U.S.-China Economic and Security Review Commission, 2008
Annual Report to Congress (Washington, DC: U.S. Government Printing
Office, 2011), pp. 93-94; Food and Drug Administration website. http://
www.fda.gov/InternationalPrograms/FDABeyondOurBordersForeignOffices/.
175. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of William Westman, April 25, 2013.
176. Department of Health and Human Services, ``Fiscal Year 2013:
Food and Drug Administration: Justifications of Estimates for
Appropriations Committees'' (Washington, DC).
177. U.S.-China Economic and Security Review Commission, Hearing on
China's Agriculture Policy and U.S. Access to China's Market, testimony
of Patty Lovera, April 25, 2013.
178. Kelli A. Giannattasio (deputy country director, U.S. Food and
Drug Administration, People's Republic of China), e-mail to Commission
staff, Washington, DC, September 6, 2013.
179. U.S.-China Economic and Security Review Commission, 2008
Annual Report to Congress (Washington, DC: U.S. Government Printing
Office, 2011), pp. 93-94.
180. JoNel Aleccia, ``China Stiff-Arms FDA on Jerky Pet Treat
Testing, Reports Show,'' NBCnews.com, August 22, 2012. http://
www.nbcnews.com/health/china-stiff-arms-fda-jerky-pet-treat-testing-
reports-show-957994.
181. Homepage, ``China International Food Safety and Quality
Conference + Expo.'' http://www.chinafoodsafety.com/.
182. Congressional-Executive Commission on China, Food and Drug
Safety, Public Health, and the Environment in China, testimony of
Steven M. Solomon, May 22, 2013.
183. Congressional-Executive Commission on China, Food and Drug
Safety, Public Health, and the Environment in China, testimony of
Steven M. Solomon, May 22, 2013.
184. USDA ``China-U.S. Plan of Strategic Cooperation in Agriculture
(2012-2017)'' (Washington, DC: February 2012). http://www.fas.usda.gov/
country/China/USDA-
MOA%20Ag%20Cooperation%20Plan%202012%20signed%20EN.pdf.
185. Jess Peterson (executive vice president, U.S. Cattlemen's
Association), telephone interview with Commission staff, March 8, 2013.
186. National Pork Producers Council, ``Comments on National Trade
Estimates Report: Sanitary and Phytosanitary Trade Barriers''
(Washington, DC, September 2011), pp. 7, 15.
187. Presentation by the U.S. Meat Export Federation, (Shanghai
China, July 26, 2013).
188. Pharmalive.com, ``China Hinders FDA Inspection Plans by
Delaying Visas,'' August 20, 2013. http://
www.pharma-manufacturing-.-com/industry-news/2013/315/?-DC-MP-=-rss.
RECOMMENDATIONS
Trends in Chinese Investment in the United States
The Commission recommends:
LCongress assess the extent to which existing laws
provide for inadequate or ineffective remedies against the
anticompetitive actions of Chinese state-owned or state-
invested enterprises operating in the U.S. market. Additional
remedies may be required to account for the fact that these
enterprises may not be operating based on commercial
considerations.
LCongress assess whether to amend the Committee on
Foreign Investment in the United States (CFIUS) statute to
allow review of greenfield investments for threats to U.S.
national security.
LCongress direct the Department of Commerce to develop
a comprehensive ongoing inventory of Chinese foreign direct
investment (FDI) in the United States and, on an annual basis,
update the inventory. The inventory should identify the
ownership structure of the entity engaging in the investment.
In preparing the inventory, the department should call on
private sector entities engaged in monitoring Chinese
investments in the United States and such other entities to
ensure that its report is complete and accurate. The department
should prepare a comprehensive report to Congress on an annual
basis identifying the FDI by Chinese entities that were made in
the previous calendar year. In its report, the department
should indicate those investments that received any assistance
from the ``Select USA'' program. The department should also
identify, on an ongoing basis, the lines of commerce that each
of the investments are engaged in.
Governance and Accountability in China's Financial System
The Commission recommends:
LCongress direct the Administration to press China for
more cooperation with the international community in order to
address the global economic risks of unregulated and
underregulated shadow banking and ask the Department of the
Treasury to provide an annual report to Congress on the risks
of shadow banking
LCongress direct the Administration, in any bilateral
investment treaty negotiations, to make fair and equitable
market access and treatment for financial services firms a
priority.
LCongress direct the Administration to assist the
Securities and Exchange Commission (SEC) and the Public Company
Accounting Oversight Board by encouraging China to develop
better regulatory oversight enforcement capabilities and more
transparent markets, during annual and biannual bilateral
dialogues, as well as multilateral dialogues.
LCongress empower the SEC to set minimum standards for
companies listing and maintaining listings on U.S. exchanges
and enable the SEC to directly delist foreign companies not in
compliance with these standards.
China's Agriculture Policy, Food Regulation, and the U.S.-China
Agriculture Trade
The Commission recommends:
LCongress monitor the implementation of the U.S.-China
Plan of Strategic Cooperation in Agriculture (2012-2017) to
ensure that U.S. funding is being allocated in such a way as to
improve the safety, sustainability, efficiency, and security of
food production in China and the United States.
LCongress require the U.S. Department of Agriculture
(USDA) and the U.S. Trade Representative (USTR) to conduct a
comprehensive review of China's agricultural subsidies,
discriminatory taxes, state trading, and procurement practices;
take account of the damages incurred by U.S. farmers and
downstream industries; and suggest appropriate remedies.
LCongress urge the Secretary of Agriculture to engage,
as part of the Joint Committee on Commerce and Trade and the
Strategic and Economic Dialogue, with his/her Chinese
counterparts to address those Chinese policies and practices
that limit U.S. exports of value-added products.
LCongress direct the Interagency Trade Enforcement
Center (ITEC) to conduct a review of the selective use of value
added tax (VAT) rebates by China and determine whether they
have a trade-distorting effect and whether the selective use of
VAT rebates is consistent with the original intent of the
General Agreement on Tariffs and Trade (GATT) provision
allowing for VAT rebates. The ITEC should prepare a report for
the U.S. Trade Representative and the relevant Committees of
jurisdiction and identify what steps should be taken to address
any GATT inconsistencies, should they be found.
LCongress direct the USDA to negotiate with China to
synchronize approvals of biotechnology to ensure stable and
predictable market access for U.S. seed companies and crop
growers in the Chinese market.
LCongress require that the USDA prepare an annual
report on competitive factors in the pork industry. In
preparing such reports, the department shall evaluate the
impact, if any, of the recent purchase of Smithfield Foods on
the ability of other U.S. producers to export pork products to
China. In addition, the report shall identify any changing
pricing structures throughout the pork production chain to
determine whether there is price or profit suppression as a
result of the Smithfield transaction.
LCongress direct the USDA to exercise extreme caution
in negotiating equivalency status for Chinese exports of
processed poultry using Chinese-origin birds. Congress should
also increase its support of USDA's Food Safety and Inspection
Service in its role as protector of meat and poultry food
safety so that the United States serves as a world model for
high-quality, science-based regulations.
LCongress ensure that the Food and Drug Administration
makes it a priority to increase the number of physical
inspections of Chinese food imports at the border; to increase
the rigor of those inspections to include testing for pathogens
and chemical, pesticide, and drug residues, and processed food
ingredients; and to conduct more frequent and thorough
inspections in food facilities in China. Congress should also
urge the USDA to permanently assign inspection personnel to
China so that the exporting plants receive regular visits by
USDA inspectors.
LCongress require the Secretary of Agriculture to
prepare a report to Congress identifying those organic food
products being imported into the United States from China. The
report should include a comprehensive evaluation of the
different methodologies employed by the United States and China
to certify that a product is organic and what steps, if any,
are being taken to harmonize any discrepancies that might
exist.
LCongress evaluate whether a requirement that U.S.
food importers purchase insurance against food-borne illnesses
and pathogens from Chinese imports would improve food safety.
Such a program would involve private sector risk insurance with
insurance companies evaluating the safety of various sources
and charging risk-based premiums based on the methods employed
by Chinese exporters to address food-borne illnesses and
pathogens.
CHAPTER 2
CHINA'S IMPACT ON
U.S. SECURITY INTERESTS
SECTION 1: MILITARY AND SECURITY
YEAR IN REVIEW
Introduction
This section--based on a Commission hearing, discussions
with outside experts and U.S. Department of Defense (DoD)
officials, and independent research--examines China's late 2012
national and military leadership transition, China's 2012
defense white paper, China's 2013 defense budget, China's
military modernization, security developments involving China,
and the U.S.-China security relationship. The section concludes
with a discussion of China's impact on U.S. security interests.
See chapter 2, section 2 and chapter 2, section 3, for coverage
of China's cyber activities and China's maritime disputes,
respectively.
Leadership Transition
President Xi Jinping Assumes Central Military Commission Chairmanship
China's late 2012 leadership transition brought the largest
turnover to the Central Military Commission (CMC) * in a
decade. Xi Jinping assumed the position of both CMC chairman
and Chinese Communist Party (CCP) general secretary at the
CCP's 18th Party Congress on November 15, 2012. President Xi
then completed his accession as China's senior leader by
becoming the People's Republic of China (PRC) president on
March 14, 2013. Although President Xi was widely expected to
eventually assume all three of China's top leadership posts,
many observers were surprised by the speed of his elevation to
CMC chairman. Official Chinese press described President Xi's
early promotion as an ``unusual twist to China's leadership
transition'' and praised outgoing CMC Chairman Hu Jintao for
his decision to step down.\1\ Mr. Hu broke with the pattern
established by his two predecessors, who retained the CMC
chairmanship for two years after finishing their terms as CCP
general secretary.
---------------------------------------------------------------------------
* The CMC is China's highest military decision-making body. Its
main responsibilities are to set military policy and strategy,
interpret Chinese Communist Party guidance for the military, and
oversee the People's Liberation Army's senior staff and service arms.
---------------------------------------------------------------------------
Cheng Li, director of research and a senior fellow at the
Brookings Institution's John L. Thornton China Center,
testified to the Commission that Mr. Hu's decision to fully
cede power signals a strengthening of CCP succession
procedures.\2\ In addition, James Mulvenon, vice president of
Defense Group Inc.'s Intelligence Division, told the Commission
that President Xi's strong and enduring ties with senior
military leaders likely contributed to his rapid promotion.
President Xi served as an aide to former Defense Minister Geng
Biao from 1979 to 1982. He also is the son of Xi Zhongxun, a
former Politburo member and revolutionary leader.\3\
---------------------------------------------------------------------------
* The PSC consists of the CCP's top-ranking leaders and is China's
highest decision-making body. The PSC guides and oversees the work of
the Politburo.
------------------------------------------------------------------------
------------------------------------------------------------------------
Factional Imbalance Emerges in China's Senior Leadership
During China's 2012 leadership transition, the ``elitist coalition''
of the CCP prevailed over the ``populist coalition'' in personnel
selections to China's highest decision-making body, securing six of
seven seats on the Politburo Standing Committee (PSC).* The elitist
coalition, which had been headed by former President Jiang Zemin and is
now led by President Xi, mainly consists of the children of Chinese
revolutionary leaders and former high-level officials. The populist
coalition, which had been headed by Mr. Hu and now is led by current
Chinese Premier Li Keqiang, primarily consists of former Chinese
Communist Youth League leaders.
Dr. Li testified to the Commission, ``Although the CCP monopolizes
power in China . . . these two coalitions have been competing for power,
influence, and control over policy initiatives since the late 1990s . .
. This dynamic structure of `one Party, two coalitions' . . . has
created something approximating a mechanism of checks and balances in
the decision making process.'' \4\ Dr. Li then explained the ``landside
victory'' by Mr. Jiang and President Xi's camp upsets the ``roughly
equal balance of power between these two coalitions'' and signals a
``profound change in the power equation.'' He speculated scandals during
the runup to the leadership transition involving two prominent
populists--then Chinese Premier Wen Jiabao and then Secretary of the CCP
Central Secretariat Ling Jihua--bolstered the elitist coalition's
leverage in the PSC personnel negotiations.\5\
The concentration of elitists on the PSC probably strengthens
President Xi's ability to pursue his policy agenda and allows Mr. Jiang
and his allies to continue to compete for influence. However, Dr. Li
stressed, ``This does not mean . . . the winner now takes all in Chinese
elite politics.'' He explained the ``balance between the two camps in
the 25-member Politburo, the Secretariat (the organization that handles
daily administrative affairs), and the CMC have largely remained
intact.'' \6\ Furthermore, prominent populist coalition leaders are well-
positioned for seats on the next PSC in 2017, as five of the seven
current PSC members can serve only one term before reaching mandatory
retirement age.
------------------------------------------------------------------------
Since becoming CMC chairman, President Xi has used public
speeches and visits to People's Liberation Army (PLA) units to
reaffirm China's long-term military modernization goals;
emphasize the importance of a strong military to the
fulfillment of the ``China Dream,'' his new political slogan
and party campaign; and signal his intent to focus on
increasing combat readiness and reducing corruption in the PLA.
``China Dream'': In November 2012, President Xi introduced
the ``China Dream'' concept, which envisions the ``great
renewal of the Chinese nation'' and the advancement of an
international system in which China's successful rise provides
an attractive alternate political model to Western ones.
Achieving the dream means building a ``moderately prosperous
society'' by 2021 and a ``modern socialist society that is
strong, democratic, cultured, and harmonious'' by 2049.\7\
Although President Xi has emphasized that ``peaceful
development'' and a stable regional environment are essential
to create the conditions for this vision, he linked its
fulfillment to a strong military in a December 2012 speech
while aboard a PLA Navy destroyer.\8\ In June 2013, official
PLA media explained, ``To the armed forces, the China dream is
the strong-army dream, the China dream leads the strong-army
dream, and the strong-army dream supports the China dream.''
\9\ According to Daniel Hartnett, research scientist at the CNA
Center for Naval Analyses, the PLA's role in the China Dream is
a significant and ``potentially worrisome development.'' Mr.
Hartnett explained:
[The policy] reflects Xi's attempt to exert his control
over the military and establish a break between himself
and his predecessors. It also provides further
justification for resources for PLA modernization in
any internal `guns versus butter' debate among China's
leadership . . . It may also signify a harder turn in
China's military policy under Xi. If the PLA is being
required to improve its combat capabilities in response
to changes in China's security environment, it could
indicate that the Chinese leadership increasingly feels
that it may have to resort to force to counter what it
sees as growing national security concerns.\10\
Combat readiness: During his first reported visit to a PLA
base as CMC chairman in December 2012, President Xi called for
the PLA to increase ``combat readiness'' through ``realistic
training.'' \11\ Combat readiness has been a central theme of
subsequent speeches to the military by President Xi and now
features prominently in official PLA statements and documents.
For example, official PLA media in January 2013 said the
military needs to prevent and overcome the ``harmful'' practice
of training ``for show.'' \12\ Furthermore, describing the
PLA's 2013 training priorities, Xiao Yunhong, deputy director
of the PLA's General Staff Department Military Training
Department, said: ``The `scent of gunpowder' in the `fighting'
will be stronger. The entire military will make `training like
real war' . . . the main theme of the entire year's training,
powerfully strengthening training of mission topics, ensuring
that as soon as there is a situation, the military will be able
to go forward and fight to victory.'' \13\
As part of its effort to strengthen realism in training,
the PLA in January 2013 announced it had designated a
mechanized infantry brigade in the Beijing Military Region as
its first dedicated ``blue force'' unit. The brigade is charged
with simulating the ``combat methods and tactics'' of foreign
forces during PLA training and exercises, according to official
PLA media.\14\ The PLA has used ``blue force'' units in
training since the 1980s,* but previously these units served on
only a temporary basis and so did not have sufficient time to
learn foreign combat methods and tactics. This new brigade is
headquartered in northern China at Zhurihe Training Base, the
PLA's largest training center and experimental site for joint
operations and ``informationized'' warfare. Official
Chinese media explained the blue force brigade has ``carefully
selected classic cases of local warfare around the world in
recent years, devoted itself to studying the advanced
operational styles of foreign armed forces, and even
[simulated] the armed forces . . . exactly in terms of
personnel organization and issuance of oral commands.'' \15\
---------------------------------------------------------------------------
* Official PLA press frequently refer to the U.S. National Training
Center at Fort Irwin, California, in discussions about PLA ``blue
force'' training, suggesting U.S. practices may have influenced the
PLA's development and implementation of the concept. PLA officers have
visited Fort Irwin to observe U.S. training on at least four occasions
(1985, 1994, 1997, and 2011). Shirley Kan, U.S.-China Military
Contacts, Issues for Congress (Washington, DC: Congressional Research
Service, July 30, 2013).
In Chinese military doctrine, ``informationization''
refers to the application of advanced information technology to
military operations. The PLA views informationization as a required
enabler of its goal to be able to win ``local wars under
informationized conditions.''
Corruption: In a meeting shortly after becoming the CMC
chairman, President Xi urged senior PLA officers ``to take a
firm stand against corruption'' and to maintain a ``strict work
style'' and ``iron discipline.'' \16\ Since then, reducing
corruption and waste in the PLA has been one of President Xi's
most consistent messages in his public speeches to the
military. In addition to rhetoric, President Xi has announced
stronger anticorruption regulations for the PLA, including
restrictions on military personnel holding banquets, drinking
excessive alcohol, and using luxury hotels.
President Xi's focus on combating corruption in the PLA is
part of the CCP's larger national effort to boost its image to
mitigate growing public disillusionment with politics and
governance in China.\17\ He also is attempting to end practices
such as paying for promotion and graft, which some observers
have suggested reduces the quality of officers, perpetuates
opposition to reforms, threatens PLA modernization and
readiness, and undermines loyalty to the CCP. In an unusually
candid December 2011 speech, PLA Logistics Department Political
Commissar General Liu Yuan, son of former Chinese President Liu
Shaoqi (1959-1968) and potential friend of President Xi
Jinping,\18\ reportedly said, ``No country can defeat China . .
. Only our corruption can destroy us and cause our armed forces
to be defeated without fighting.'' \19\ General Liu in a later
speech reportedly explained, ``Certain individuals exchange
public money, public goods, public office, and public affairs
for personal gain, flouting the law and party codes of conduct,
even resorting to verbal abuse and threats, clandestine plots
and set ups . . . They deploy all of the tricks of the mafia
trade within the army itself.'' \20\
Nevertheless, empirical evidence of PLA corruption remains
limited. Only two high-profile PLA corruption cases have become
known since 2005. Admiral Wang Shouye was sentenced to life in
prison in 2006 for embezzling approximately $20 million.
General Gu Junshan was removed from his post in 2012, and the
investigation apparently is ongoing.\21\ Both Admiral Wang and
General Gu had served as the deputy director of the PLA General
Logistics Department, suggesting officers in logistics
positions may be more susceptible to corruption, or corruption
charges, due to their involvement in infrastructure and natural
resources.
Uniformed Members of the Central Military Commission
In the weeks prior to the CCP's 18th Party Congress, seven
new uniformed PLA officers were appointed to the CMC. In his
testimony to the Commission, Dr. Mulvenon speculated that
``some of the choices were short-term compromises,'' as five of
the seven appointees can serve only one term on the CMC before
reaching mandatory retirement age. Dr. Mulvenon also noted the
elevation of two vice chairmen with strictly operational
backgrounds allows China observers to dispense with the popular
misconception that one of the positions is set aside for a
political officer.\22\ Roy Kamphausen, senior advisor for
political and security affairs at the National Bureau of Asian
Research, stressed to the Commission that the PLA remains a
``party army'' * even without the presence of a political
officer in one of the CMC's top positions, because all PLA
officers interact extensively with CCP leaders and eventually
serve on the CCP Central Committee after joining the CMC.\23\
---------------------------------------------------------------------------
* The PLA is the armed branch of the CCP, not the military force of
the PRC.
---------------------------------------------------------------------------
The new uniformed CMC members likely are more professional
than previous CMC officers due to their more diverse careers,
advanced education, more sophisticated training, and increased
exposure to foreign militaries. Their predecessors tended to
have specialized careers, less education and training, and
limited interactions with foreign militaries outside the Soviet
Union. However, because China has not fought a major war since
the Sino-Vietnam War in 1979, the new uniformed CMC members
have limited combat experience. In contrast, most of their
predecessors participated in long and large-scale campaigns
during the Chinese Civil War (1946 to 1949) and Korean War
(1950 to 1953).\24\
---------------------------------------------------------------------------
CMC members are listed according to official protocol
order. An asterisk indicates the officer is a new CMC member.
= General Fan Changlong's promotion to CMC vice chairman surprised
many observers. Not only did General Fan have a relatively low public
profile until 2012, but also he was promoted from Military Region
commander to CMC vice chairman without first serving as a CMC member.
General Fan will reach mandatory retirement age at the CCP's 19th Party
Congress, so will serve only one term. U.S.-China Economic and Security
Review Commission, Hearing on China's New Leadership and Implications
for the United States, written testimony of James C. Mulvenon, February
7, 2013.
Figure 1: Members of the 18th Central Military Commission
------------------------------------------------------------------------
CMC Member Position
------------------------------------------------------------------------
Xi Jinping Chairman
------------------------------------------------------------------------
General Fan Changlong * Vice Chairman
------------------------------------------------------------------------
Figure 1: Members of the 18th Central Military Commission --
Continued
------------------------------------------------------------------------
CMC Member Position
------------------------------------------------------------------------
General Xu Qiliang Vice Chairman
------------------------------------------------------------------------
General Chang Wanquan Minister of National Defense
------------------------------------------------------------------------
General Fang Fenghui * General Staff Department Chief
------------------------------------------------------------------------
General Zhang Yang * General Political Department Director
------------------------------------------------------------------------
General Zhao Keshi * General Logistics Department Director
------------------------------------------------------------------------
General Zhang Youxia * General Armament Department Director
------------------------------------------------------------------------
Admiral Wu Shengli Sec. PLA Navy Commander
------------------------------------------------------------------------
General Ma Xiaotian * PLA Air Force Commander
------------------------------------------------------------------------
General Wei Fenghe * Second Artillery Corps Commander
------------------------------------------------------------------------
Source: Open Source Center, OSC Graphic: Organizational Chart of China's
Military Leadership 2013 (Washington, DC: May 22, 2013). OSC ID:
CPF2013 0521017002. http://www.opensource.gov.
Defense White Paper
In April 2013, China released the latest version of its
biennial defense white paper.para. \25\ This is the first
defense white paper published since President Xi became CMC
chairman. Although Chinese military leaders likely began to
draft the document before President Xi assumed the position,
official Chinese press suggests it contains strategic
priorities specific to him.\26\
---------------------------------------------------------------------------
Sec. Admiral Wu Shengli, who has served as PLA Navy Commander since
2006 and was a member of the 17th CMC, was widely expected to be
elevated to CMC vice chairman or minister of defense. Dr. Mulvenon in
his testimony to the Commission speculated Beijing may have considered
Admiral Wu's role in leading the PLA Navy's modernization program--a
top priority for Beijing--too critical to move him into a different
position. U.S.-China Economic and Security Review Commission, Hearing
on China's New Leadership and Implications for the United States,
written testimony of James C. Mulvenon, February 7, 2013.
para. Defense white papers--China's most authoritative statements
on national security--are published by the State Council's Information
Office and approved by the CMC, Ministry of National Defense, and State
Council. Beijing primarily uses these documents as a public relations
tool to help ease deepening international concern over China's military
modernization and answer calls for greater transparency.
---------------------------------------------------------------------------
Unlike previous iterations, which provided a comprehensive
overview of Chinese military and security issues, the 2012
defense white paper focuses on a theme--the PLA's growing role
in military missions other than war. The current version also
is shorter and less formal and ideological than previous ones.
Major General Chen Zhou, a senior fellow at the PLA Academy of
Military Science and the document's coordinating author, said
China in the future plans to alternate between ``subject-
specific'' defense white papers, such as the 2012 iteration,
and the traditional ``comprehensive'' format.\27\
Official Chinese media hailed the 2012 defense white paper
as a milestone in transparency, citing the ``declassification''
of military details.\28\ However, most of this was widely-known
information that Beijing had never officially acknowledged,
such as the designations of Group Armies under the Military
Regions and the breakdown of how the PLA distributes personnel
among its service arms. Furthermore, as in previous iterations,
the 2012 defense white paper offers no substantive information
on important defense issues, including the defense budget;
nuclear weapons; and the types and numbers of weapon systems
already fielded, being developed, or under consideration for
acquisition.
Defense Budget
In March 2013, China announced its official defense budget
for 2013 rose 10.7 percent in nominal terms to 720.168 billion
RMB (approximately $117.39 billion), signaling the new
leadership's support for the PLA's ongoing modernization
efforts. This figure represents 5.3 percent of total government
outlays \29\ and approximately 1.3 percent of estimated gross
domestic product (GDP).\30\ China's official annual defense
budget now has increased for 22 consecutive years and more than
doubled since 2006. Most Western analysts agree Beijing likely
will retain the ability--even with slower growth rates of its
GDP and government revenue--to fund its ongoing military
modernization for at least the near term.\31\
It is difficult to estimate China's actual defense spending
due to a number of reasons, including (1) the uncertainty
involved in determining how China's purchasing power parity
affects the cost of China's foreign military purchases and
domestic goods and services and (2) Beijing's omission of major
defense-related expenditures--such as purchases of advanced
weapons, research and development programs, domestic security
spending, and local government support to the PLA--from its
official figures. The Institute of International Strategic
Studies assesses China's actual defense spending is 40 to 50
percent higher than the official figure.\32\ DoD estimated
China's actual defense spending in 2012 fell between $135
billion and $215 billion, which was approximately 20 to 90
percent higher than China's announced defense budget.\33\
Military Modernization
Aircraft Carrier Developments
In September 2012, China commissioned its first aircraft
carrier, the Liaoning, after approximately six years of
renovation work on the former Soviet hull and one year of sea
trials. China continues to develop a fixed-wing carrier
aviation capability, which is necessary for the carrier to
perform air defense and offensive strike missions. The PLA Navy
conducted its first successful carrier-based takeoff and
landing with the Jian-15 (J-15) in November 2012, certified its
first group of aircraft carrier pilots and landing signal
officers on the carrier's first operational deployment from
June to July 2013, and verified the flight deck operations
process in September 2013.\34\ The PLA Navy will continue to
conduct short deployments and shipboard aviation training until
2015 to 2016, when China's first J-15 regiment is expected to
become operational.
China plans to follow the Liaoning with at least two
indigenously built aircraft carriers. The first likely will
enter service by 2020 and the second by 2025. As China's
aircraft carrier force expands and matures, Beijing will
improve its ability to project air power, particularly in the
South China Sea, and to perform a range of other missions, such
as airborne early warning, antisubmarine warfare, helicopter
support to ground forces, humanitarian assistance, search and
rescue, and naval presence operations.\35\
Sea-based Nuclear Deterrent Nears Initial Operational Capability
China's Julang-2 (JL-2) submarine-launched ballistic
missile (SLBM) is expected to reach initial operational
capability by late 2013.\36\ The JL-2, when mated with the PLA
Navy's JIN-class nuclear ballistic missile submarine (SSBN),
will give China its first credible * sea-based nuclear
deterrent. The JIN SSBN/JL-2 weapon system will have a range of
approximately 4,000 nautical miles (nm), allowing the PLA Navy
to target the continental United States from China's littoral
waters.\37\ China has deployed three JIN SSBNs and probably
will field two additional units by 2020.\38\ China also is
developing its next generation SSBN, the Type 096,\39\ which
likely will improve the range, mobility, stealth, and lethality
of the PLA Navy's nuclear deterrent.
---------------------------------------------------------------------------
* The PLA Navy operates one SSBN/SLBM weapon system with the XIA-
class SSBN and the JL-1 SLBM. However, the status of this weapon system
is unclear, and DoD does not consider it to be a credible threat. U.S.
Department of Defense, Annual Report to Congress: Military and Security
Developments Involving the People's Republic of China 2013 (Washington,
DC: May 2013), p. 6; U.S. Office of Naval Intelligence, The People's
Liberation Army Navy: A Modern Navy with Chinese Characteristics
(Suitland, MD: 2009), p. 23.
---------------------------------------------------------------------------
Submarine and Surface Fleets Modernizing and Expanding
The PLA Navy continues to steadily increase its inventory
of modern submarines and surface combatants. China is known to
be building seven classes of ships simultaneously but may be
constructing additional classes.\40\ See figures 2-5 below for
more information on PLA Navy orders of battle from 1990 to
2020.
LIn 2012, China began building four improved
variants of its SHANG-class nuclear attack submarine (SSN).
China also continues production of the YUAN-class conventional
submarine (SS), some of which include an air-independent
propulsion system that allows for extended duration
operations, and the JIN SSBN. Furthermore, China is pursuing
two new classes of nuclear submarines--the Type 095 guided-
missile attack submarine (SSGN) and the Type 096 SSBN--and may
jointly develop four advanced conventional submarines with
Russia.\41\ The PLA Navy's growing inventory of modern nuclear
and conventional submarines will significantly enhance China's
ability to strike opposing surface ships throughout the Western
Pacific and allow it to protect future sea-based nuclear
deterrent patrollers and aircraft carrier task groups.\42\
---------------------------------------------------------------------------
Air-independent propulsion (AIP) is a method of generating
electrical power in a conventional submarine while it operates
submerged. The use of an AIP system reduces the need for a submarine to
surface or come to periscope depth--where it is easier to detect--to
recharge its batteries.
LIn 2012, China launched two new surface
combatants--the LUYANG III-class guided-missile destroyer (DDG)
and the JIANGDAO-class corvette--and resumed construction of
the LUYANG II-class DDG after a brief hiatus. China also
continues serial production of the JIANGKAI II-class guided-
missile frigate. Most of these units likely will be operational
by 2015. The expanding and modernizing surface force will
improve Beijing's ability to project power in the East and
South China Seas and the Western Pacific. It also will help the
PLA Navy fulfill its growing set of nontraditional missions
beyond China's immediate periphery. These missions include
defense of distant maritime trade routes, humanitarian
---------------------------------------------------------------------------
assistance, and counterpiracy.\43\
LIn 2012, the PLA Navy commissioned two YUZHAO-
class amphibious transport docks (LPD), bringing its LPD
inventory to three. The YUZHAO LPD can carry a mix of air-
cushion landing craft, amphibious armored vehicles,
helicopters, and marines. This will provide the PLA Navy with
additional flexibility while performing missions such as
amphibious assault, humanitarian assistance, and counterpiracy
and improve China's ability to seize and hold Taiwan's offshore
islands. China may build additional YUZHAO LPDs and probably
will field a new landing helicopter assault ship, called the
Type 081, by 2018.\44\
LIn 2013, China added two upgraded FUCHI-class
auxiliary replenishment oilers (AOR) to its fleet, raising its
number of AORs from five to seven. The increased number of
naval support ships better equips the PLA Navy's surface fleet,
including future aircraft carrier task groups and expeditionary
forces, to sustain high-tempo operations at longer ranges.\45\
According to Chinese military experts Andrew Erickson and
Gabe Collins, ``by 2015, China will likely be second globally
in numbers of large warships built and commissioned since the
Cold War's end . . . by 2020, barring a U.S. naval renaissance,
it is possible that China will become the world's leading
military shipbuilder in terms of numbers of submarines, surface
combatants and other naval surface vessels produced per year.''
\46\ The Office of Naval Intelligence projects China will have
between 313 and 342 submarines and surface combatants by 2020,
including approximately 60 submarines that are able to employ
submarine-launched intercontinental ballistic missiles or
antiship cruise missiles and approximately 75 surface
combatants that are able to conduct multiple missions or that
have been extensively upgraded since 1992.\47\
Figure 2: PLA Navy Submarine Orders-of-Battle 1990-2020
----------------------------------------------------------------------------------------------------------------
Type 1990 1995 2000 2005 2010 2015 2020
----------------------------------------------------------------------------------------------------------------
Diesel Attack 88 43 60 51 54 57-62 59-64
----------------------------------------------------------------------------------------------------------------
Nuclear Attack 4 5 5 6 6 6-8 6-9
----------------------------------------------------------------------------------------------------------------
Nuclear Ballistic 1 1 1 2 3 3-5 4-5
----------------------------------------------------------------------------------------------------------------
Total 93 49 66 59 63 66-75 69-78
----------------------------------------------------------------------------------------------------------------
Sources: Numbers from 1990 to 1995 are based on information from various editions of the International Institute
for Strategic Studies' The Military Balance series, reprinted in Anthony H. Cordesman et al., Chinese Military
Modernization and Force Development: A Western Perspective (Washington, DC: Center for Strategic and
International Studies, 2013), pp. 157-163. Numbers from 2000 to 2010 and projections for 2015 and 2020 were
provided by the U.S. Office of Naval Intelligence. U.S. Office of Naval Intelligence, PLA Navy Orders of
Battle 2000-2020, written response to request for information provided to the U.S.-China Economic and Security
Review Commission, Suitland, MD, June 24, 2013.
Figure 3: PLA Navy Submarine Orders-of-Battle 1990-2020, Approximate Percent Modern *
----------------------------------------------------------------------------------------------------------------
Type 1990 1995 2000 2005 2010 2015 2020
----------------------------------------------------------------------------------------------------------------
Diesel Attack 0% 0% 7% 40% 50% 70% 75%
----------------------------------------------------------------------------------------------------------------
Nuclear Attack 0% 0% 0% 33% 33% 70% 100%
----------------------------------------------------------------------------------------------------------------
Sources: Approximate percentages from 1990 to 1995 are based on information from various editions of the
International Institute for Strategic Studies' The Military Balance series, reprinted in Anthony H. Cordesman
et al., Chinese Military Modernization and Force Development: A Western Perspective (Washington, DC: Center
for Strategic and International Studies, 2013), pp. 157-163. Approximate percentages from 2000 to 2010 and
projections for 2015 and 2020 were provided by the U.S. Office of Naval Intelligence. U.S. Office of Naval
Intelligence, PLA Navy Orders of Battle 2000-2020, written response to request for information provided to the
U.S.-China Economic and Security Review Commission, Suitland, MD, June 24, 2013.
---------------------------------------------------------------------------
* Modern submarines are those able to employ submarine-launched
intercontinental ballistic missiles or antiship cruise missiles. U.S.
Office of Naval Intelligence, PLA Navy Orders of Battle 2000-2020,
written response to request for information provided to the U.S.-China
Economic and Security Review Commission, Suitland, MD, June 24, 2013.
Figure 4: PLA Navy Surface Orders-of-Battle 1990-2020
----------------------------------------------------------------------------------------------------------------
Type 1990 1995 2000 2005 2010 2015 2020
----------------------------------------------------------------------------------------------------------------
Aircraft Carriers 0 0 0 0 0 1 1-2
----------------------------------------------------------------------------------------------------------------
Destroyers 19 18 21 21 25 28-32 30-34
----------------------------------------------------------------------------------------------------------------
Frigates 37 37 37 43 49 52-56 54-58
----------------------------------------------------------------------------------------------------------------
Corvettes 0 0 0 0 0 20-25 24-30
----------------------------------------------------------------------------------------------------------------
Amphibious Ships 58 50 60 43 55 53-55 50-55
----------------------------------------------------------------------------------------------------------------
Coastal Patrol
215 217 100 51 85 85 85
(Missile)
----------------------------------------------------------------------------------------------------------------
Total 329 322 218 158 214 239-254 244-264
----------------------------------------------------------------------------------------------------------------
Sources: Numbers from 1990 to 1995 are based on information from various editions of the International Institute
for Strategic Studies' The Military Balance series, reprinted in Anthony H. Cordesman et al., Chinese Military
Modernization and Force Development: A Western Perspective (Washington, D.C: Center for Strategic and
International Studies, 2013), pp. 157-163. Numbers from 2000 to 2010 and projections for 2015 and 2020 were
provided by the U.S. Office of Naval Intelligence. U.S. Office of Naval Intelligence, PLA Navy Orders of
Battle 2000-2020, written response to request for information provided to the U.S.-China Economic and Security
Review Commission, Suitland, MD, June 24, 2013.
---------------------------------------------------------------------------
Totals do not include all types and sizes of surface
ships, such as mine warfare and auxiliary ships.
Figure 5: PLA Navy Surface Orders-of-Battle 1990-2020, Approximate Percent Modern
----------------------------------------------------------------------------------------------------------------
Type 1990 1995 2000 2005 2010 2015 2020
----------------------------------------------------------------------------------------------------------------
Destroyers 0% 5% 20% 40% 50% 70% 85%
----------------------------------------------------------------------------------------------------------------
Frigates 0% 8% 25% 35% 45% 70% 85%
----------------------------------------------------------------------------------------------------------------
Sources: Approximate percentages from 1990 to 1995 are based on information from various editions of the
International Institute for Strategic Studies' The Military Balance series, reprinted in Anthony H. Cordesman
et al., Chinese Military Modernization and Force Development: A Western Perspective (Washington, D.C: Center
for Strategic and International Studies, 2013), pp. 157-163. Approximate percentages from 2000 to 2010 and
projections for 2015 and 2020 were provided by the U.S. Office of Naval Intelligence. U.S. Office of Naval
Intelligence, PLA Navy Orders of Battle 2000-2020, written response to request for information provided to the
U.S.-China Economic and Security Review Commission, Suitland, MD, June 24, 2013.
---------------------------------------------------------------------------
= Modern surface ships are those able to conduct multiple missions
or that have been extensively upgraded since 1992. U.S. Office of Naval
Intelligence, PLA Navy Orders of Battle 2000-2020, written response to
request for information provided to the U.S.-China Economic and
Security Review Commission, Suitland, MD, June 24, 2013.
------------------------------------------------------------------------
------------------------------------------------------------------------
Sustaining the U.S. Military's ``Rebalance'' to Asia
In June 2010, then U.S. Secretary of Defense Robert Gates announced
the ``U.S. defense posture in Asia is shifting to one that is more
geographically distributed, operationally resilient, and politically
sustainable.'' \48\ In January 2012, DoD's Defense Strategic Guidance
declared the U.S. military will ``of necessity rebalance toward the
Asia'' by emphasizing existing alliances, expanding its networks of
cooperation with ``emerging'' partners, and investing in military
capabilities to ensure access to and freedom to maneuver within the
region.\49\ The rebalance is a whole-of-government effort that also
includes diplomacy, trade, and development.
However, there is growing concern in the United States and among U.S.
allies and partners that DoD will be unable to follow through on its
commitment to the rebalance due to declining defense budgets and
emerging crises elsewhere in the world. U.S. Defense Secretary Chuck
Hagel in July 2013 said Washington would have to choose between a
smaller, modern military and a larger, older one if sequester-level
funding continues.
In the first approach, we would trade away size
for high-end capability. This would further shrink
the active Army[from570,000]50to
between380,000to450,000troops, reduce the number of
carrier strike groups from 11 to 8 or 9, draw down
the Marine Corps from 182,000 to between 150,000
and 175,000, and retire older Air Force bombers. We
would protect investments to counter anti-access
and area denial threats, such as the long-range
strike family of systems, submarine cruise missile
upgrades, and the Joint Strike Fighter, and we
would continue to make cyber capabilities and
special operations forces a high priority. This
strategic choice would result in a force that would
be technologically dominant, but would be much
smaller and able to go fewer places and do fewer
things, especially if crisis occurred at the same
time in different regions of the world.
The second approach would trade away high-end
capability for size. We would look to sustain our
capacity for regional power projection and presence
by making more limited cuts to ground forces,
ships, and aircraft. But we would cancel or curtail
many modernization programs, slow the growth of
cyber enhancements, and reduce special operations
forces. Cuts on this scale would, in effect, be a
decade-long modernization holiday. The military
could find its equipment and weapons systems--many
of which are already near the end of their service
lives--less effective against more technologically
advanced adversaries. \51\
U.S. Chief of Naval Operations Admiral Jonathan Greenert explained the
U.S. Navy's role in the rebalance: ``as directed by the 2012 Defense
Strategic Guidance . . . the [U.S.] Navy formulated and implemented a
plan to rebalance our forces, their homeports, our capabilities, and our
intellectual capital and part- nerships toward the Asia Pacific.'' 52
Specifically, the U.S. Navy
------------------------------------------------------------------------
------------------------------------------------------------------------
------------------------------------------------------------------------
Sustaining the U.S. Military's ``Rebalance'' to Asia--Continued
aims to increase its presence in the Asia Pacific from about 50 ships in
2013 to 60 ships by 2020 and ``rebalance homeports to 60 percent'' in
the region by 2020.\53\ However, Admiral Greenert has warned
constraints in the current budget environment could delay or prevent
the U.S. Navy from achieving these objectives. In a September 2013
hearing held by the U.S. House Committee on Armed Services, Admiral
Greenert testified:
. . . If fiscally constrained to the revised
discretionary caps, over the long term (2013-2023),
the Navy of 2020 would not be able to execute the
missions described in the [Defense Strategic
Guidance] . . . One potential fiscal and
programmatic scenario would result in a `2020
Fleet' of about 255-260 ships, about 30 less than
today, and about 40 less than the [U.S. Navy's 2014
budget] submission. It would include 1-2 fewer
[carrier strike groups], and 1-2 fewer [amphibious
readiness groups] than today. With regard to the
[Defense Strategic Guidance] and presence, in this
particular scenario the `2020 Fleet' would not
increase presence in the Asia-Pacific, which would
stay at about 50 ships in 2020. This would largely
negate the ship force structure portion of [the
U.S.] plan to rebalance to the Asia Pacific region
directed by the [Defense Strategic Guidance] . . .
Overall, in this scenario, development of our
capabilities to project power would not stay ahead
of potential adversaries' [anti-access/area denial]
capabilities.\54\
------------------------------------------------------------------------
Developing Sea-based Land Attack Capability
China currently does not have the ability to strike land
targets with sea-based cruise missiles. However, the PLA Navy
likely is developing a land attack capability for its Type-095
SSGN and LUYANG III DDG. Modern submarines and surface
combatants equipped with land attack cruise missiles (LACMs)
will complement the PLA's growing inventory of air- and ground-
based LACMs and ballistic missiles, enhancing Beijing's
flexibility for attacking land targets throughout the Western
Pacific, including U.S. facilities in Guam.\55\
Antiship Ballistic Missile Update
In 2010, China deployed the Dong Feng-21D (DF-21D) antiship
ballistic missile (ASBM). The DF-21D, which has a range
exceeding 810 nm, provides Beijing with the ability to threaten
large surface ships, such as U.S. Navy aircraft carriers,
throughout the Western Pacific. China is fielding additional
DF-21D missiles and may be developing a longer-range
variant.\56\
Possible Test of New Antisatellite Capability
On May 13, 2013, China fired a missile into space from the
Xichang Satellite Launch Center in western China.* The missile
``appeared to be on a ballistic trajectory to nearly
geosynchronous Earth orbit,'' according to DoD.
Geosynchronous Earth orbit can be achieved at about 22,000 to
23,000 miles above the Earth's equator.= This launch is the
world's highest known suborbital launch since the U.S. Gravity
Probe A in 1976 and China's highest known suborbital launch to
date, according to Jonathan McDowell, a scientist at the
Harvard-Smithsonian Center for Astrophysics.\57\
---------------------------------------------------------------------------
* China's Academy of Sciences National Space Science Center issued
the following statement regarding China's May missile launch: ``This
test used a high altitude space probe rocket, which carried a payload
of multiple scientific detectors such as Langmuir probes, high energy
particle detectors, magnetometers, and barium powder release test
devices, etc. to perform original state detection of high energy
particles and electromagnetic field strength in the ionosphere and near
earth space.'' Xinhua, ``China Successfully Carries out a High Altitude
Scientific Measurement Test,'' May 14, 2013. OSC ID:
CPP-2013-0514003004.
DoD issued the following statement regarding China's May
missile launch: ``We detected a launch on May 13 from within China. The
launch appeared to be on a ballistic trajectory nearly to
geosynchronous Earth orbit. We tracked several objects during the
flight but did not observe the insertion of any objects into orbit and
no objects associated with this launch remain in space. Based upon
observations, we assess that the objects reentered the atmosphere above
the Indian Ocean. We defer any further questions to the government of
China.'' Jonathan McDowell, ``Kunpeng-7,'' Space Report, May 21, 2013.
http://www.planet4589.org/pipermail/jsr/2013-May/000051.html.
= For an overview of the different classes of orbit, see NASA Earth
Observatory, ``Three Classes of Orbit.'' http://
earthobservatory.nasa.gov/Features/OrbitsCatalog/page2.php.
---------------------------------------------------------------------------
U.S. defense agencies reportedly assess the launch was the
first test of a new antisatellite (ASAT) capability, according
to two U.S. press reports citing unnamed U.S. officials.\58\
Beijing, however, claims the launch was part of a high-altitude
scientific experiment for China's National Space Science
Center. A Chinese Ministry of Foreign Affairs spokesperson said
he was ``not aware'' of an ASAT test and then reiterated
China's ``longstanding stance to make peaceful use of the outer
space and oppose weaponization and arms race in the outer
space.'' \59\ DoD did not comment on the U.S. press reports or
provide information on its assessment of the relationship
between the May missile launch and China's ASAT program.
Although it is difficult to draw a definitive conclusion
about the nature of the missile launch without more information
from China or DoD, available data suggest it was intended to
test at least the launch vehicle component of a new high-
altitude ASAT capability.\60\ If the launch is part of China's
ASAT program, Beijing's attempt to disguise it as a scientific
experiment would demonstrate a lack of transparency about its
objectives and activities in space. Furthermore, such a test
would signal China's intent to develop an ASAT capability to
target satellites in an altitude range that includes U.S.
Global Positioning System (GPS) and many U.S. military and
intelligence satellites.Sec. In a potential conflict, this
capability could allow China to threaten the U.S. military's
ability to detect foreign missiles and provide secure
communications, navigation, and precision missile guidance.
Beijing's January 2007 destruction of an aging Chinese FY-1C
weather satellite demonstrated it has the capability to target
satellites in low Earth orbit (an altitude between about 100 to
1,200 miles), such as remote sensing satellites.
---------------------------------------------------------------------------
Sec. It is not clear from U.S. press reports which type of attack
mechanism the potential new ASAT capability would employ. For example,
it could use a ``kinetic kill vehicle'' to disable or destroy a
satellite through the force of a direct collision. The new ASAT
capability also could employ electronic warfare or directed energy
weapons to temporarily degrade a satellite's capabilities without
permanently destroying or damaging it. For an overview of the different
types of ASAT attack methods and technologies, see David Wright, Laura
Grego, and Lisbeth Gronland, The Physics of Space Security: A Reference
Manual (Cambridge, MA: American Academy of Arts and Sciences and Union
of Concerned Scientists, 2005). http://www.ucsusa.org/assets/documents/
nwgs/physics-space-security.pdf.
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Developing Operationally Responsive Space Capability
On September 25, 2013, China launched a satellite into
space from the Jiuquan Satellite Launch Center in western
China. Official Chinese press claims the satellite, carried on
a missile called the ``Kuaizhou,'' will ``monitor natural
disasters and provide disaster relief information'' for China's
National Remote Sensing Center.\61\ However, Gregory Kulacki,
China project manager and senior analyst at the Union of
Concerned Scientists, explains that, in addition to orbiting a
weather satellite, the launch served to test a new solid-fueled
launch vehicle. Solid-fueled rockets are simpler to operate,
cheaper, and have fewer logistical requirements than liquid-
fueled rockets, making them ideal for quick launches with
minimal preparation. According to Dr. Kulacki, ``This
capability would allow [the PLA] to rapidly replace satellites
that might be damaged or destroyed in an anti-satellite attack
with small but `good enough' satellites able to restore at
least some of the functions of the satellites lost.'' The U.S.
military has been developing a similar capability, which it
refers to as ``Operationally Responsive Space,'' since at least
2006.* \62\
---------------------------------------------------------------------------
* DoD's Operationally Responsive Space Office, established in 2007,
is charged with planning and preparing ``for the rapid development of
highly responsive space capabilities that enable delivery of timely
warfighting effects and, when directed, develop and support deployment
and operations of these capabilities to enhance and assure support to
Joint Force Commanders' and other users' needs for on-demand space
support, augmentation, and reconstitution.'' U.S. Operationally
Responsive Space Office, Mission Statement. http://ors.csd.disa.mil/
mission/.
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Beidou Regional Satellite Navigation System Complete
On December 27, 2012, China's Beidou regional satellite
navigation system became fully operational and
available for commercial use. Using 16 satellites and a network
of ground stations, Beidou provides subscribers in Asia with
24-hour precision, navigation, and timing services, as well as
the ability to send and receive text messages up to 120 Chinese
characters.\63\ China plans to expand Beidou into a global
satellite navigation system by 2020.\64\
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The regional Beidou system, which China refers to as
Beidou-2, grew out of an earlier satellite constellation, known as
Beidou-1. Beidou-1 provided limited precision, navigation, and timing
services in China and a small portion of East Asia but served primarily
as a developmental platform for future projects. For more information
on China's civilian and military space activities, see U.S.-China
Economic and Security Review Commission, 2011 Annual Report to Congress
(Washington, DC: U.S. Government Printing Office, November 2011), pp.
198-222.
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China's Satellite Navigation Office emphasized Beidou's
importance to the PLA and Chinese commercial interests, stating
the system meets the ``demands of China's national security,
economic development, technological advances and social
progress . . . safeguard[s] national interests . . . enhance[s]
the comprehensive national strength . . . promote[s] the
development of satellite navigation industry . . . make[s]
contributions to human civilization and social development . .
. [and] serve[s] the world and benefit[s] mankind.'' \65\
LBeidou is a critical part of China's stated goal
to prepare for fighting wars under ``informationized
conditions,'' which includes an emphasis on developing the
PLA's C4ISR * and electronic warfare capabilities. The PLA is
integrating Beidou into its systems to improve its command and
control and long-range precision strike capabilities and to
reduce the PLA's reliance on foreign precision, navigation, and
timing services, such as GPS.\66\
---------------------------------------------------------------------------
* C4ISR refers to command, control, communications, computers,
intelligence, surveillance, and reconnaissance.
LBeijing seeks to use Beidou to gain 15-20 percent
of China's domestic satellite navigation market share by 2015
and 70-80 percent by 2020. GPS currently has about 95 percent
---------------------------------------------------------------------------
of China's market.\67\
LBeijing is marketing Beidou's services to
countries throughout Asia and has already reached agreements
with Thailand, Laos, Brunei, and Pakistan to provide precision,
navigation, and timing services for government and military
customers at heavily subsidized costs.\68\ These agreements
include provisions allowing Beijing to build satellite ground
stations outside of China, which will be used to increase
Beidou's range and signal strength.\69\
Manned Space Program Reaches Milestone
In mid-June 2013, three astronauts aboard China's Shenzhou-
10 space shuttle docked with the Tiangong-1, which is a small
orbiting experimental space lab that China launched in 2011.
Shenzhou-10 was China's fifth manned spaceflight, second manned
mission to the Tiangong-1, and longest human spaceflight to
date. Over the 15-day mission, the crew conducted both
automatic and manual dockings, as well as medical,
technological, and scientific experiments while aboard the
Tiangong-1.\70\ China's second-ever female astronaut, Wang
Yaping, gave a physics lesson from the space lab to more than
60 million Chinese students via live broadcast.\71\ President
Xi attended the Shenzhou-10 launch and later told the crew in a
video conference: ``The space dream is a crucial part of our
nation-building dream. With the rapid development of China's
space industry, a great step forward will be made by the
Chinese people in the exploration of space.'' \72\
According to Vice Premier Zhang Gaoli, Shenzhou-10's
multiple successful dockings with the Tiangong-1 mark the
achievement of the second phase of China's three-phase manned
space program. In phase one, China launched several unmanned
missions to develop technologies necessary for its first manned
spaceflight in 2003. In phase two, China honed its spacecraft
rendezvous and docking capabilities. In phase three, scheduled
for completion by 2023, China plans to launch a permanent
manned space station into orbit.\73\
Official Chinese statements emphasize the civilian aspects
of China's space program and only implicitly refer to the PLA's
role in China's space strategy. Beijing's 2011 Space White
Paper states China's objectives in space are the following:
to explore outer space and to enhance understanding of
the Earth and the cosmos; to utilize outer space for
peaceful purposes, promote human civilization and
social progress, and to benefit the whole of mankind;
to meet the demands of economic development, scientific
and technological development, national security and
social progress; and to improve the scientific and
cultural knowledge of the Chinese people, protect
China's national rights and interests, and build up its
national comprehensive strength.\74\
However, the PLA has a significant role in most aspects of
China's space activities. Scott Pace, director of the Space
Policy Institute at George Washington University's Elliott
School of International Affairs, testified to the Commission:
``China's human space flight efforts are managed by elements of
the PLA and require industrial capabilities that are the same
as those used for military programs. Thus it might be more
accurate to say that China has civil space activities, such as
science and exploration, but does not have a civil space
program.'' \75\ This suggests even ostensibly civilian
projects, such as the Shenzhou missions and the Tiangong-series
space labs, support the development of PLA space, counterspace,
and conventional capabilities.
Indigenous Large Transport Aircraft Conducts First Flight Test
In late January 2013, China conducted the first test flight
of its indigenously developed cargo transport aircraft, the
Yun-20 (Y-20). China previously was unable to build heavy
transports, so it has relied on a handful of Russian Ilyushin-
76 (Il-76) aircraft for strategic airlift since the 1990s.
Following the exposure of key shortcomings in the PLA's ability
to conduct disaster relief after China's 2008 Sichuan
earthquake, official Chinese media highlighted the PLA's lack
of strategic airlift is an ``obvious insufficiency'' that
``affects the overall elevation of [China's] core military
capability.'' \76\
Aircraft specifications provided by official Chinese media
indicate the Y-20 can carry about twice the cargo load of the
PLA's only operational transport, the IL-76, and about three
times the cargo load of the U.S. C-130. Although the Y-20
currently uses Russian engines, the plane's chief designer said
China ultimately plans to replace these with Chinese engines
that feature better fuel efficiency and thrust-weight
ratio.\77\ China also may produce variants of the Y-20 aircraft
for specialized missions, such as airborne refueling, airborne
early warning, command and control, and electronic warfare.\78\
Once large-scale deliveries of the new plane begin, the Y-
20 aircraft will be able to support a variety of domestic and
international military operations. The Y-20 will enhance the
PLA's ability to respond to internal security crises and border
contingencies, support international peacekeeping and
humanitarian assistance operations, and project power in a
regional conflict.\79\
New Bomber Deployed
In June 2013, the PLA Air Force began to receive new
Hongzha-6K (H-6K) bomber aircraft.\80\ The H-6K--an improved
variant of the H-6 (originally adapted from a late-1950s Soviet
design)--has extended range and can carry China's new long-
range LACM. The bomber/LACM weapon system provides the PLA Air
Force with the ability to conduct conventional strikes against
regional targets throughout the Western Pacific, including U.S.
facilities in Guam.\81\ Although the H-6K airframe could be
modified to carry a nuclear-tipped air-launched LACM, and
China's LACMs likely have the ability to carry a nuclear
warhead, there is no evidence to confirm China is deploying
nuclear warheads on any of its air-launched LACMs.\82\
------------------------------------------------------------------------
------------------------------------------------------------------------
Marketing New Armed Unmanned Aerial Vehicle
At China's major biennial airshow in November 2012, the Chengdu
Aircraft Design Institute, which falls under the state-owned Aviation
Industry Corporation of China, presented for the first time a static
display of the Wing Loong armed unmanned aerial vehicle (UAV).\83\ The
Wing Loong appeared again at the Paris Air Show in June 2013, marking
China's first display of an armed UAV at an international defense
exhibition.\84\ A representative of China's largest defense aviation
exporter at the air show revealed that as many as six countries in
Africa and Asia are negotiating with China to purchase the Wing
Loong.\85\
Press observers noted the Wing Loong's close resemblance to the MQ-9
Reaper, one of the U.S.'s chief attack UAVs, leading some analysts to
speculate Chinese espionage may have contributed to the Wing Loong's
development.\86\ Furthermore, U.S. cybersecurity company FireEye in
September 2013 exposed an extensive PLA cyber espionage campaign
targeting top aerospace and defense firms for information on U.S. drone
technology.\87\ FireEye attributed the campaign to a cyber threat group
known as ``Comment Group,'' which U.S. cybersecurity company Mandiant
has linked to the 2nd Bureau of the PLA General Staff Department's Third
Department.\88\ This suggests cyber espionage may have played a role in
the new UAV's design. For more information on China's cyber actors and
operations, see chapter 2, section 2, of this Report, ``China's Cyber
Activities.''
------------------------------------------------------------------------
Security Developments
Expanding Military Operations in Foreign Exclusive Economic Zones
In 2012, the PLA Navy for the first time began to conduct
maritime intelligence collection operations in foreign
exclusive economic zones (EEZs) * without providing advance
notification.\89\ In one instance, the PLA Navy operated near
Hawaii during a major U.S.-led multilateral exercise.\90\ This
activity runs counter to Beijing's insistence that foreign
militaries provide notification and receive approval prior to
operating in China's claimed EEZ. In June 2013, a senior PLA
official confirmed China's naval deployments to foreign EEZs
and said China is ``sort of reciprocating America's
reconnaissance in our EEZ by sending our ships to America's EEZ
for reconnaissance.'' The PLA official added China has done so
only ``a few times,'' in contrast to the U.S. and Japan's
``almost daily reconnaissance'' of China.\91\
---------------------------------------------------------------------------
* According to the United Nations Convention on the Law of the Sea,
a coastal state is entitled to an EEZ, a 200 nautical mile zone
extending from its coastline within which that state can exercise
jurisdiction to explore and exploit natural resources, but not full
sovereignty.
---------------------------------------------------------------------------
Although the United States and China agree on the basic
role and right of a coastal state to explore, exploit,
conserve, and manage natural resources within its EEZ, the two
countries have conflicting views on a coastal state's right to
regulate foreign military activity in its EEZ, whether they are
exercises, military surveys, reconnaissance, or other military
operations.\92\ Differences on this issue emerged in the 1970s
during United Nations Convention on the Law of the Sea (UNCLOS)
negotiations,\93\ reflecting the contrast in priorities between
coastal states with interests in the control and security of
their coastal waters and seagoing states with interests in the
freedom of the seas. When UNCLOS negotiations concluded in
1982, China was a coastal nation with a littoral navy, whereas
the United States was a global maritime power with a blue water
navy that operated regularly outside its coastal waters.*
---------------------------------------------------------------------------
* China ratified UNCLOS in 1996. Although the United States has not
ratified UNCLOS, it contends the binding principles of UNCLOS conform
to customary international law.
---------------------------------------------------------------------------
Today, China continues to assert its right to regulate
foreign military activities in its claimed EEZ, a minority
practice among the world's nations. China's position is
based largely on its view that it has the right to prevent any
activity that directly or indirectly threatens its security or
economic interests. The United States, maintaining military
vessels have high seas freedoms in EEZs, contends China must
have due regard for the rights and duties of other states
exercising those freedoms in a manner compatible with
UNCLOS.\94\ Viewing its own position as one based on
international norms, the United States ``encourage[s]'' similar
operations by China, according to U.S. Pacific Command
Commander Admiral Samuel Locklear.\95\
---------------------------------------------------------------------------
According to the U.S. Navy, only 27 countries share this
view, including China, Bangladesh, Burma, Cambodia, India, Malaysia,
Maldives, North Korea, Pakistan, Sri Lanka, Thailand, and Vietnam.
Ronald O'Rourke, Maritime Territorial and Exclusive Economic Zone (EEZ)
Disputes Involving China: Issues for Congress (Washington, DC:
Congressional Research Service, April 2013), p. 4.
---------------------------------------------------------------------------
China also asserts jurisdiction of its domestic laws in its
claimed EEZ. The 1998 Law of the People's Republic of China on
the Exclusive Economic Zone and Continental Shelf requires
foreign entities to obtain Chinese government approval prior to
conducting fishing, natural resource exploitation, and marine
scientific research in China's claimed EEZ.\96\ China
classifies U.S. military and hydrographic surveys as marine
scientific research falling under the jurisdiction of this
law.= The United States considers both types of survey high
seas freedoms.
---------------------------------------------------------------------------
= UNCLOS also addresses marine scientific research in the EEZ and
continental shelf. United Nations Convention on the Law of the Sea,
``Article 246: Marine scientific research in the exclusive economic
zone and on the continental shelf.'' http://www.un.org/depts/los/
convention----agreements/texts/unclos/part13.htm; U.S.-China Economic
and Security Review Commission, 2008 Annual Report to Congress
(Washington, DC: U.S. Government Printing Office, November 2008), pp.
143-147.
---------------------------------------------------------------------------
The different interpretations of maritime rights and
freedoms in the past decade have led to bilateral tensions and
occasionally incidents between U.S. and Chinese maritime and
air forces.
One Chinese scholar has suggested the PLA's acknowledgement
of its foreign EEZ operations demonstrates that Beijing's
``changing concept of maritime affairs'' is ``moving [China]
towards international norms.'' \97\ Nevertheless, it is
unlikely China will completely abandon its existing policy on
military activities in EEZs, as doing so would undermine the
legal foundation it has sought to build over time as an
objector to the international norm. Therefore, in order to
avoid being accused of holding contradictory positions, as well
as to manage regional perception of its expanding naval
activity, Beijing probably will seek to justify its activities
using some of the following approaches:
LContinue to rely on domestic law to legitimize a
coastal state's authority to regulate foreign military
activities in its EEZ. Under this view, which is at odds with
state practice by an overwhelming majority of the world's
nations, the PLA could justify operating in foreign EEZs absent
a coastal state's legislation addressing this matter.
LSeek to distinguish U.S. activity from its own by
continuing to classify U.S. operations as marine scientific
research that requires coastal state approval.
LDifferentiate between U.S. activity off the coast
of the Chinese mainland and Chinese operations along the outer
reaches of the U.S. geographic periphery.
LPortray such Chinese operations as mere
reciprocation of similar U.S. activities.
LContrast China's less frequent operations with
what it describes as the U.S.'s ``almost daily
reconnaissance.'' \98\
First Deployment of Infantry to Support UN Peacekeeping Operation
In July 2013, the PLA began to deploy its first
peacekeepers to the UN Multidimensional Integrated
Stabilization Mission in Mali (MINUSMA).* \99\ The PLA
contingent, which together consists of nearly 400 troops that
were dispatched in two groups, includes what Beijing calls a
``security force'' from the PLA's 16th Group Army.\100\ This
marks the first time Beijing has deployed infantry to support a
peacekeeping operation since it began participating in UN
missions in 1990.\101\ The PLA's security force in Mali is
responsible for providing force protection for ``MINUSMA
headquarters and the living areas of peacekeeping forces.''
\102\ China previously had limited the PLA's participation
in peacekeeping operations to noncombat troops--mainly
military observers; staff officers; and engineering, medical,
and transportation personnel. For example, China in January
2012 deployed a ``guard'' unit--consisting of about 50 PLA
troops--to the UN Mission in South Sudan.\103\ However, the
unit's mission was limited to protecting China's own noncombat
troops. Beijing explained the guards were needed because the
United Nations was not providing protection for Chinese
peacekeepers.\104\
---------------------------------------------------------------------------
* MINUSMA took over peacekeeping responsibilities from the African-
led International Support Mission in Mali (AFISMA) on July 1, 2013.
AFISMA had been providing security since January 2013 when Islamic
rebels were ousted from the country. United Nations, MINUSMA: United
Nations Stabilization Mission in Mali. http: // www.un.org/en/
peacekeeping/missions/minusma/background.shtml.
Since 2004, China has been contributing police units to UN
missions. However, these police units consist of civilians--usually
drawn from provincial-level border police units--and are not under the
command of the PLA. Bates Gill and Chin-Hao Huang, China's Expanding
Role in Peacekeeping: Prospects and Policy Implications (Stockholm,
Sweden: Stockholm International Peace Research Institute, November
2009), p. 8.
---------------------------------------------------------------------------
Official Chinese statements have downplayed the PLA's
deployment of infantry to Mali, likely to avoid raising
international concerns about Beijing's intentions and the PLA's
growing military capabilities. These statements also have
emphasized that China's participation in MINUSMA is consistent
with its long-espoused non-interference policy, because Mali
requested military assistance. Beijing distinguishes between
international action requested by a sovereign state and
international action it perceives as designed to overthrow a
sovereign state. Beijing fears the latter could legitimize
regime change and external intervention and thus threaten
China's own core interests of sovereignty and territorial
integrity.
China and Russia Hold Large Naval Exercise
In early July, the PLA Navy and the Russian Federation Navy
held ``Joint Sea-2013'' in the Sea of Japan, outside of
Vladivostok, Russia. Seven PLA Navy ships--six modern surface
combatants and a replenishment ship--participated in the
exercise, which included training for antisubmarine operations,
antisurface operations, air defense, replenishment at sea,
counterpiracy, and search and rescue and concluded with a
maritime parade. Official Chinese media highlighted Joint Sea-
2013 as the largest deployment of Chinese forces in any joint
foreign exercise and the first time the PLA Navy has
participated in an ``overseas joint exercise far away from [a]
naval base and without [a] support system.'' \105\
China and Russia have conducted military drills bilaterally
or under the auspices of the Shanghai Cooperation Organization
since 2005, but this was only the second naval exercise between
the two countries. The first exercise occurred in April 2012 in
the Yellow Sea. According to a PLA Navy official, ``From now
on, the friendly cooperation between Chinese and Russian navies
will be further developed, and the exercise will gradually
develop towards normalization and institutionalization.'' \106\
Furthermore, during an interview with an official Chinese
television station, a Chinese commentator noted, ``The
antisubmarine subject should be said to be an important subject
of this China-Russia joint exercise because antisubmarine
exercise has always been a top-secret exercise of various
countries . . . this shows the military cooperation between the
two countries has reached a certain high level of mutual
trust.'' \107\
Most Western observers maintain China and Russia are not
entering a new stage in security cooperation. Jeffrey Mankoff,
a fellow and deputy director of the Russia and Eurasia Program
at the Center for Strategic and International Studies, said,
``Sporadic cooperation between the Russian and Chinese
militaries [does not] alter the fact that China's assertiveness
worries Russia at least as much as it worries the United
States. Russian military commanders acknowledge that they see
China as a potential foe, even as official statements continue
to focus on the alleged threat from the United States and [the
North Atlantic Treaty Organization].'' \108\ Furthermore, two
of Russia's largest military exercises since the Soviet era,
held in July 2010 and July 2013, focused on its Far East region
and were indicative of training for a conflict scenario
involving China.\109\
Nevertheless, most U.S. observers agree the United States
should carefully monitor the status of the China-Russia
relationship. Dean Cheng and Ariel Cohen, both senior research
fellows at the Heritage Foundation, warned, ``If a close Sino-
Russian strategic relationship develops, it could limit the
capacity of the U.S. to act abroad and undermine economic
freedom, democracy, and human rights in Greater Eurasia.''
\110\
China-India Border Tensions Flare
Border tensions between China and India flared after New
Delhi claimed a contingent of 30 to 50 PLA soldiers crossed
about 12 miles beyond the Line of Actual Control * between the
two countries on April 15 and stayed there for three weeks.
According to New Delhi, PLA soldiers frequently conduct border
incursions (more than 600 times over the last three years) but
do not usually cross more than a few miles over the Line of
Actual Control nor stay there longer than several hours.\111\
---------------------------------------------------------------------------
* The Line of Actual Control is the effective border between China
and India. The 2,400 mile-long Line of Actual Control traverses the
Aksai Chin, the northern part of the Sikkim State, and crosses the
McMahon Line in Arunachal Pradesh State.
---------------------------------------------------------------------------
Beijing denied Chinese troops had crossed into Indian
territory. A Chinese Ministry of Foreign Affairs spokesperson
said, ``China has always acted in strict compliance with
relevant agreements and protocols between the two countries on
maintaining peace and tranquility in the Line of Actual Control
area along the border . . . Chinese patrol troops have never
crossed the line.'' \112\ Chinese Premier Li Keqiang attempted
to downplay the incident and the risk of conflict. During a
state visit to India, he insisted that ``a few clouds in the
sky cannot shut out the brilliant rays of our friendship.''
Premier Li did not directly address the alleged Chinese
incursion, though he said ``both sides believe we need to
improve various border-related mechanisms that we have put into
place and make them more efficient, and we need to
appropriately manage and resolve our differences.'' \113\
Beijing and New Delhi resolved the April border impasse in
May after a series of talks and agreed to pursue a formal
agreement to build trust and confidence between the border
troops. The two sides signed the agreement during the Indian
prime minister's trip to China in October 2013.\114\
Nevertheless, the potential for periodic low-level
confrontations between border patrols to escalate likely will
persist. Indian media have reported several additional albeit
briefer incursions by Chinese troops since the April standoff.
Furthermore, both China and India continue to boost their
militaries' capabilities on the border, adding to mutual
suspicion. This has left both sides sensitive to each other's
border activities and disposed toward worst-case perceptions of
the other sides' intentions and activities. Ely Ratner and
Alexander Sullivan of the Center for a New American Security,
warn: ``more intense strategic competition between India and
China would reverberate throughout the continent, exacerbating
tensions in Central Asia, the Indian Ocean, and Southeast Asia.
Disruptions to the Asian engine of economic growth caused by
these tensions could debilitate the global economy.'' \115\
``Subtle Shift'' in China's North Korea Policy?
As has been discussed in previous Commission reports, China
for decades has provided North Korea with economic and
political support and shielded Pyongyang from harsh punishment
by the international community for its destabilizing rhetoric
and activities.\116\ However, North Korea's recent
provocations--including its December 2012 long-range rocket
launch and February 2013 nuclear test--have led to a ``subtle
shift'' in China's policy toward North Korea, according to
former U.S. Assistant Secretary of State for East Asian and
Pacific Affairs Kurt Campbell.\117\ Observable manifestations
of this ``subtle shift'' are Beijing's stronger and higher-
level public signals of its frustration with Pyongyang. Most
notably, President Xi indirectly criticized North Korea in an
April speech when he said, ``No one should be allowed to throw
a region and even the whole world into chaos for selfish
gains.'' \118\ This appears to be the first time a Chinese
president has publicly reproached North Korea.
Nevertheless, most U.S. analysts agree China has not
fundamentally altered its North Korea strategy. Beijing's
recent diplomatic moves have been temporary, limited, easily
reversible, and more symbolic than substantive.
LIn September 2013, several Chinese government
ministries jointly issued a new 236-page list of technologies
and materials to be banned from export to North Korea.\119\ The
proscription list focuses on dual-use items that could be used
to produce weapons of mass destruction or ballistic missiles.
However, according to the Nautilus Institute, ``nothing
indicates that by issuing tighter controls, China is
fundamentally changing its policy toward North Korea, let alone
abandoning it . . . The degree to which China enforces the
prohibition of trade in items on this list will mostly
determine the success of the program.'' \120\
LAlthough China in March 2013 voted to approve new
and strengthened UN Security Council sanctions on North
Korea,\121\ Stephanie Kleine-Ahlbrandt, then North East Asia
project director and China adviser for the International Crisis
Group, in July noted that China's implementation of the
sanctions had been ``underwhelming.'' \122\
LIn May 2013, state-owned Bank of China Ltd.
closed its account with North Korea's Foreign Trade Bank.
However,
Ms. Kleine-Ahlbrant explains, ``It is unclear whether there was
any money in the Foreign Trade Bank's accounts when they were
closed. For months already, North Koreans had been limiting
their use of major Chinese banks to avoid scrutiny. Third
countries are often used for such transactions, as well as
provincial Chinese banks, which operate with considerably more
autonomy than the larger state-owned banks. Furthermore, most
of North Korean trade with China skirts the banking system
altogether by engaging in cash transactions via trading
companies in China, processing payments in the form of gold or
gemstones, or even bartering.'' \123\
Joel Wuthnow, analyst at the CNA Center for Naval Analyses,
warns: ``this refrain is familiar. For instance, China's harsh
rhetoric and vote in favor of UN sanctions after North Korea's
2006 nuclear test was followed in 2007 by a push for dialogue;
a similar pattern developed after China's approval of sanctions
in response to [North Korean] provocations in 2009, with a more
conciliatory approach in 2010.'' \124\
United States-China Security Relationship
China Seeking ``New Type of Major-Country Relationship'' with the
United States
Throughout 2013, Beijing called for a ``new type of major-
country relationship'' * with the United States. Official
Chinese statements claim the ``new type'' relationship is
intended to promote more stable relations between the two
countries and avoid or, if necessary, manage tensions that
history suggests could occur as China rises. The concept, which
was formulated by Beijing in 2011, has been referenced
increasingly in official Chinese statements and press since
February 2012, when then presumptive Chinese President Xi
evoked it during a visit to the United States.\125\ The ``new
type'' relationship was a central theme of the June 2013 summit
between President Obama and President Xi in Sunnylands,
California.\126\
---------------------------------------------------------------------------
* Chinese statements also use the term ``new type of great power
relationship.'' Both phrases refer to the same concept.
---------------------------------------------------------------------------
The ``new type'' concept, like many Chinese policy slogans,
is vaguely defined in order to provide Chinese officials with
the flexibility to frame it in different ways for different
circumstances and audiences. Chinese officials likely will
attempt to use the concept to serve a number of Beijing's
strategic objectives, including the following:
LDevelop deeper and more frequent military
communication to improve the two countries' abilities to manage
crises if and when they arise.
LPressure the United States to respect China's
``core interests,'' which are to preserve China's political
system and national security, protect Chinese sovereignty and
territorial integrity, and sustain economic and social
development.
LPromote an image of China as a constructive actor
seeking common solutions to regional and global issues.
LConvince the United States that China is
proactively seeking to build a peaceful and cooperative
bilateral relationship.
LPressure the United States to cease its military
reconnaissance and survey operations in China's claimed EEZ,
reduce U.S. arms sales to Taiwan, and relax restrictions on the
military-to-military relationship, particularly those imposed
in the 2000 National Defense Authorization Act. \127\
---------------------------------------------------------------------------
Section 1201 of the 2000 National Defense Authorization
Act prohibits DoD from authorizing any military-to-military exchange or
contact with representatives of the PLA if that exchange or contact
would create a national security risk for the United States. United
States Congress, ``National Defense Authorization Act for Fiscal Year
2000,'' Public Law 106-65, October 5, 1999.