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2005 Report to Congress On China’s WTO Compliance

This is the fourth annual report to Congress on compliance by China with commitments made in connection with its accession to the World Trade Organization. 

December 11, 2005
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EXECUTIVE SUMMARY
(Download the full report)

With regard to WTO compliance, for the last four years, China has taken important steps in implementing the numerous commitments that it undertook upon its WTO accession on December 11, 2001. With most of China’s key commitments scheduled to be phased in fully by December 11, 2004, this past year provided a first critical glimpse at what to expect of China as a WTO member with its full range of commitments in place. At this point, however, China’s implementation work is still incomplete. While China has made important progress in implementing specific commitments and in adhering to the ongoing obligations of a WTO member, there are still serious problems in some important areas, especially in the enforcement of intellectual property rights (IPR).
 
Many of the shortfalls in China’s WTO compliance efforts seem to stem from China’s incomplete transition from being a state-planned economy. As several U.S. trade associations highlighted in their written comments and testimony before USTR and the other agencies that comprise the Trade Policy Staff Committee, China has not yet fully embraced the key WTO principles of market access, non-discrimination and national treatment, nor has China fully institutionalized market mechanisms and made its trade regime predictable and transparent. While China has made some important progress, it continued to use an array of industrial policy tools in 2005 to promote or protect favored sectors and industries, and these tools at times collide with China’s WTO obligations. The problems that result continue to foster a view of China in some quarters as an unfair and protectionist trader rather than an open and non-discriminatory economy that is one of the major engines of growth in the world.
 
When the United States and other WTO members concluded 15 years of negotiations with China over the specific terms of China’s entry into the WTO at the end of 2001, China had agreed to extensive, far-reaching and often complex commitments to change its trade regime, at all levels of government. China had committed to implement a set of sweeping reforms that required it to lower trade barriers in virtually every sector of the economy, provide national treatment and improved market access to goods and services imported from the United States and other WTO members, and protect intellectual property rights. China had also agreed to special rules regarding subsidies and the operation of state-owned enterprises, in light of the state’s large role in China’s economy. The United States and other WTO members envisioned that faithful WTO implementation by China would reduce the ability of non-market forces, including government policies and directives from government officials, to intervene in the market to direct or restrain trade flows. Eventually, it was expected that China’s economy would operate on market principles, like its trading partners’ economies.
 
As previously reported, the first year of China’s WTO membership – 2002 – saw significant but uneven progress, as China took steps to repeal, revise or enact more than one thousand laws, regulations and other measures, in an effort to bring its trading system into compliance with WTO standards.  By 2003, however, China’s WTO implementation efforts had lost a significant amount of momentum, and we identified numerous specific WTO-related problems. As those problems mounted in 2003, the Administration responded by stepping up its efforts to engage China’s senior leaders, culminating in December 2003, when President Bush and Premier Wen committed to upgrade the level of discussions and undertake an intensive program of bilateral interaction – with a view to resolving problems in the U.S.-China trade relationship and facilitating increased U.S. exports to China. This new approach began to take shape with the high-level Joint Commission on Commerce and Trade (JCCT) meeting in April 2004. At that meeting, the two sides resolved no fewer than seven potential disputes over China’s WTO compliance. Three months later, the United States and China were also able to mutually resolve the first-ever dispute settlement case brought against China at the WTO, in which the United States, with support from four other WTO members, had challenged discriminatory value-added tax (VAT) policies that favored Chinese-produced semiconductors over imported semiconductors.
 
By the end of last year, expectations for significant WTO implementation progress by China were high, given the success of the April 2004 JCCT meeting and promises by China’s senior leaders that China would fully and in a timely manner adhere to the scheduled phase-in of key commitments on trading rights and distribution services by December 11, 2004. However, in 2005, old problems like ineffective IPR enforcement persisted and new problems in areas like distribution services began to emerge. The Administration utilized high-level engagement, expert-to-expert discussions and WTO mechanisms to address these problems, and in particular, initiated a comprehensive new strategy (outlined below) for obtaining improvements in China’s IPR enforcement. Many of these efforts culminated in a meeting of the JCCT in July 2005, co- chaired by Vice Premier Wu Yi on the Chinese side and Secretary of Commerce Gutierrez and United States Trade Representative Portman on the U.S. side.  That meeting achieved measured progress on a range of concerns, but it fell short of realizing the many win-win outcomes of the April 2004 JCCT meeting.
 
As 2005 was drawing to an end, many U.S. companies described achievement of the full market access and predictability and transparency in trade envisioned by China’s WTO accession agreement as “essential.” These companies saw Chinese governmental efforts to manage trade as the root cause of many of the problems they faced. As one trade association expressed it, “we hope that China, under the auspices of its WTO obligations, continues its progress towards removing the state from the Chinese economy. . . . [W]e believe the Chinese government must recognize that the market, left to its own devices, is the most effective vehicle for Chinese economic growth.” Another trade association emphasized that “without concrete, sustained, and visible progress, China’s political challenge in the United States will become more serious.”
 
The areas of particular concern to the United States and U.S. industry, and most in need of improved WTO compliance efforts, are summarized below.
 
Intellectual Property Rights
 
China has undertaken substantial efforts to implement its commitment to overhaul its legal regime to ensure the protection of intellectual property rights in accordance with the WTO’s Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS Agreement).
While the United States continues to work with China in some problem areas, China has done a relatively good job of overhauling its legal regime. However, China has been much less successful in enforcing its laws and regulations and ensuring the effective IPR enforcement required by the TRIPS Agreement. With most in U.S. industry reporting no significant reduction in IPR infringement levels in 2005, IPR enforcement remains problematic. Counterfeiting and piracy in China remain at epidemic levels and cause serious economic harm to U.S. businesses in virtually every sector of the economy.
 
The Administration places the highest priority on improving IPR enforcement in China. Building on its engagement with China at the April 2004 JCCT meeting, the United States took several aggressive steps in 2005 in an effort to obtain meaningful progress. First, the United States conducted an out-of-cycle review under the Special 301 provisions of U.S. trade law, which involved a systematic evaluation of China’s entire IPR enforcement regime, supported by
submissions from U.S. manufacturers and businesses to document IPR infringement to the extent possible. At the conclusion of this review in April 2005, the Administration elevated China to the Special 301 “Priority Watch” list and set forth a comprehensive strategy for addressing China’s ineffective IPR enforcement regime, which included the possible use of WTO mechanisms, as appropriate. The United States immediately began to pursue this strategy during the run-up to the July 2005 JCCT meeting, as the United States sought to strengthen the commitments that China had made at the April 2004 JCCT meeting and to obtain China’s commitment for greater involvement of its police authorities in IPR enforcement matters. China subsequently agreed to take a series of specific actions designed to increase criminal prosecutions of IPR violators, improve enforcement at the border, counter piracy of movies, audio-visual products and software, address Internet-related piracy and assist small- and medium-sized U.S. companies experiencing China-related IPR problems, among other things. Because lack of transparency on IPR infringement levels and enforcement activities in China has hampered the United States’ ability to assess the effectiveness of China’s efforts to improve IPR enforcement since the April 2004 JCCT meeting, the United States also submitted a request to China under Article 63.3 of the TRIPS Agreement in October 2005. The United States’ request, made in conjunction with similar requests by Japan and Switzerland, seeks detailed information from China on its IPR enforcement efforts over the last four years. China’s response to these requests, anticipated in early 2006, will help the United States further evaluate whether China is taking all necessary steps to address the rampant IPR infringement found throughout China.
 
The United States is committed to working constructively with China to significantly reduce IPR infringement levels in China and continues to devote extra staff and resources, both in Washington and in Beijing, to address the many aspects of this problem. At the same time, the United States remains prepared to take whatever action is necessary and appropriate to ensure that China develops and implements an effective system of IPR enforcement, as required by the TRIPS Agreement.
 
Trading Rights and Distribution Services
 
China was scheduled to phase in two key WTO commitments by December 11, 2004. These commitments called for full liberalization of trading rights – the right to import and export – and distribution services, including wholesaling services, commission agents’ services, retail services and franchising services, as well as related services. As had been agreed at the JCCT meeting in April 2004, China implemented its trading rights commitments nearly six months ahead of schedule, permitting companies and individuals to import and export goods in China directly without having to use a middleman. However, delay and confusion characterized China’s efforts to implement its distribution services commitments, substantially hindering the ability of U.S.  and other foreign companies to begin engaging freely in the distribution of goods in China. It took several months and repeated U.S. engagement for China to address many of the problems that arose in this critical area, and some problems still remain. In addition, China only issued the regulations implementing its commitment to open its market for sales away from a fixed location, also known as “direct selling”, in September 2005, and these regulations contain several problematic provisions that the United States has urged China to reconsider. The Administration will continue to pursue these important issues in 2006 to ensure that China fully meets its commitments.
 
Industrial Policies
 
Since acceding to the WTO, China has increasingly resorted to industrial policies that limit market access by non-Chinese origin goods or bring substantial government resources to support increased exports. The objective of these policies seems to be to support the development of Chinese industries that are higher up the economic value chain than the industries that make up China’s current labor-intensive base, or simply to protect less competitive domestic industries.
 
In 2005, examples of these industrial policies are readily evident. They include the issuance of regulations on auto parts tariffs that serve to prolong prohibited local content requirements for motor vehicles, the telecommunications regulator’s interference in commercial negotiations over royalty payments to intellectual property rights holders in the area of 3G standards, the pursuit of unique national standards in many areas of high technology that could lead to the extraction of technology or intellectual property from foreign rights-holders, draft government procurement regulations mandating purchases of Chinese-produced software, a new steel industrial policy that calls for the state’s management of nearly every major aspect of China’s steel industry, continuing export restrictions on coke, and excessive government subsidization benefitting a range of domestic industries in China. Some of these policies appear to conflict with China’s WTO commitments in the areas of market access, national treatment and technology transfer, among others.
 
The United States and China made important progress in resolving U.S. concerns regarding the draft software procurement regulations at the July 2005 JCCT meeting. However, serious disagreements over a number of the other industrial policies remain, particularly regarding China’s regulations on auto parts tariffs and China’s export restrictions on coke. The United States will continue to press China on these issues and will take further appropriate actions seeking elimination of these policies.
 
Services
 
Overall, the United States continued to enjoy a substantial surplus in trade in services with China in 2005, and the market for U.S. service providers in China remains promising. However, in some sectors, the expectations of the United States and other WTO members when agreeing to China’s commitments to increase market access and remove restrictions have not been fully realized. Chinese regulatory authorities continue to frustrate efforts of U.S. providers of insurance, telecommunications, construction and engineering and other services to achieve their full market potential in China through the use of an opaque regulatory process, overly burdensome licensing and operating requirements, and other means. In 2005, China did follow through on commitments made at the April 2004 and July 2005 JCCT meetings by resuming a dialogue on insurance issues, and China also was moving forward with a promised dialogue on telecommunications  issues.
 
Agriculture
 
U.S. agricultural exports to China in 2004 totaled $5.5 billion, and so far 2005 has also been a very successful year, with China becoming the United States’ fourth largest agricultural export market. U.S. exports of agricultural commodities, particularly cotton and wheat, have increased dramatically in recent years, and U.S. exports of soybeans continued to perform strongly – on target in 2005 to well exceed $2 billion for the third year in a row, with China remaining the leading export destination for U.S. soybeans.
 
While U.S. exports of agricultural commodities largely fulfill the potential envisoned by U.S. negotiators during the years leading up to China’s WTO accession, China’s WTO implementation in the agricultural sector is beset by uncertainty, largely because of selective intervention in the market by China’s regulatory authorities. As in past years, capricious practices by Chinese customs and quarantine officials can delay or halt shipments of agricultural products into China, while sanitary and phytosanitary standards with questionable scientific bases and a generally opaque regulatory regime frequently bedevil traders in agricultural commodities, who require as much predictability and transparency as possible in order to preserve margins and reduce the already substantial risks involved in commodities trade. As a result, trade with China in the agricultural sector remains among the least transparent and predictable of the world’s major markets. In 2006, the United States will continue to pursue vigorous bilateral engagement with China in order to obtain progress on its outstanding concerns, particularly with regard to China’s continuing ban on the importation of U.S. beef products.
 
Transparency
 
One of the fundamental principles of the WTO Agreement, reinforced throughout China’s   WTO accession agreement, is transparency. Adherence to this principle permits markets to function effectively and reduces opportunities for officials to engage in trade-distorting practices behind closed doors. While China’s transparency commitments in many ways require a profound historical shift, China has made important strides to improve transparency across a wide range of national and provincial authorities.  China’s Ministry of Commerce (MOFCOM) remains most notable for its impressive moves toward adopting WTO transparency norms. However, many other ministries and agencies continue to resist the changes called for by China’s WTO obligations. As a result, many of China’s regulatory regimes continue to suffer from systemic opacity, frustrating efforts of foreign – and domestic – businesses to achieve the potential benefits of China’s WTO accession.
 
Conclusion
 
In 2006, the Administration will continue its relentless efforts to ensure China’s full compliance with its WTO commitments, with particular emphasis on reducing IPR infringement levels in China, and on pressing China to make greater efforts to institutionalize market mechanisms and make its trade regime more predictable and transparent.  Throughout this process, the Administration remains committed to working constructively with China to ensure that all of the benefits of China’s WTO membership are fully realized by U.S. workers, businesses, farmers, service providers and consumers and that problems in our trade relationship are appropriately resolved. When this cooperative process is not successful, however, the Administration will not hesitate to employ the full range of dispute settlement and other tools available as a result of China’s accession to the WTO. At the same time, the Administration will continue to strictly enforce its trade laws to ensure that U.S. interests are not harmed by unfair trade practices.
 
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