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2007 Report to Congress On China’s WTO Compliance

This is the sixth annual report to Congress on compliance by China with commitments made in connection with its accession to the World Trade Organization. 
December 11, 2007
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EXECUTIVE SUMMARY
 

EXECUTIVE SUMMARY

 
After six years of membership in the World Trade Organization, China is no longer a new WTO member.  Almost all of the specific commitments that China made when it acceded to the WTO on December 11, 2001, were due to be implemented over a period of five years, ending one year ago.  Accordingly, the United States has been working to hold China fully accountable – just as we, and others, hold ourselves accountable – as a mature member of the international trading system, placing a strong emphasis on China’s adherence to WTO rules.  Over the last year, the United States intensified its frank bilateral engagement with China.  The United States also took enforcement actions at the WTO in key areas where dialogue had not resolved our WTO-related concerns, and through our reliance on rules-based dispute settlement the United States, and China, did make some progress.  The focus of this bilateral and multilateral engagement included significant market impediments and trade-distortive practices as well as other Chinese government policies and practices where the United States has needed to respond in order to defend fundamental WTO principles.
 
The United States brought three new WTO cases against China in 2007. In the first one, the United States challenged several prohibited subsidy programs benefiting a wide cross-section of China’s manufactured goods, and we were pleased that China later agreed to settle this case by committing to eliminate all of the subsidies at issue.  The United States also filed a challenge to key aspects of China’s IPR enforcement regime, along with a challenge to market access restrictions affecting the importation and distribution of copyright-intensive products such as theatrical films, DVDs, music, books and journals.  Each of these three WTO cases implicates fundamental WTO obligations, as does the WTO case filed by the United States in 2006 challenging China’s use of prohibited local content requirements in the auto sector.
 
While pursuing these multilateral enforcement initiatives, the United States also pursued intensified, focused bilateral dialogue with China.  Working together, the United States and China pursued a set of formal and informal bilateral dialogues and meetings, including numerous working groups and plenary meetings under the auspices of the U.S.-China Joint Commission on Commerce and Trade (JCCT) and the U.S.-China Strategic Economic Dialogue (SED).  Through these avenues, the United States sought resolutions to particular pressing trade issues and encouraged China to accelerate its movement away from reliance on government intervention and toward full institutionalization of market mechanisms.  This bilateral engagement produced near-term results in several areas in 2007, including the suspension of overly burdensome testing and certification requirements for medical devices, the granting of biotechnology safety certificate approvals, increased insurance market access, expanded business scopes for foreign banks and securities companies, and a new civil aviation agreement. On other pressing trade issues, the United States and China continue to work together in search of pragmatic solutions.
 
As noted above, constructive bilateral engagement during the WTO dispute settlement process also facilitated the resolution of one of the WTO disputes brought by the United States, along with Mexico, in 2007.  Following two rounds of formal WTO consultations in Geneva in March and June, the United States and China were able to reach agreement in November on the immediate elimination of all of the prohibited subsidies being challenged by the United States. Hopefully, China’s willingness to take this step represents a conscious decision by China’s policymakers to abandon the type of economic thinking that had relied on this highly distortive type of government intervention in the past.  At a minimum, as U.S. Trade Representative Schwab remarked, it showed that “two great trading nations can work together to resolve disputes to their mutual benefit.”  It also demonstrated that the Administration’s policy of serious dialogue and resolute enforcement is delivering real results.
 
All of these developments demonstrate the substantial ongoing benefits to the United States – including U.S. workers, businesses, farmers, service providers and consumers – from China’s WTO membership.  Prodded by the United States and other WTO members since acceding to the WTO, China has taken many impressive steps to reform its economy, making progress in implementing a set of sweeping commitments that required it to reduce tariff rates, eliminate
non-tariff barriers, provide national treatment and improved market access to goods and services imported from the United States and other WTO members, improve transparency and protect intellectual property rights.  Although not complete in every respect, China’s implementation of its WTO commitments has led to significant increases in U.S.-China trade, including U.S. exports to China, while deepening China’s integration into the international trading system and facilitating and strengthening the rule of law and economic reforms that China began nearly three decades ago.  That said, more still needs to be done.
 
In 2007, U.S. industry began to focus less on the implementation of specific commitments that China made upon entering the WTO and more on China’s shortcomings in observing basic obligations of WTO membership as well as Chinese policies and practices that undermine previously implemented commitments.  According to one major trade association’s testimony this Fall before USTR and the other agencies that comprise the Trade Policy Staff Committee:
 
[M]any of the market access concerns on which U.S. companies increasingly focus are no longer the result of China’s failure to implement specific WTO commitments.  Rather, these concerns focus on China’s laws, policies, and practices that deviate from the WTO’s national treatment principle, its inadequate protection of intellectual property rights, its insufficiently transparent legal and regulatory processes, and its opaque development of technical and product standards that may favor local companies. . . . [T]he hurdles U.S. companies must overcome result from China’s falling short of full adherence to the general principles of the WTO and not from an unwillingness to implement the specific commitments of its entry agreement.
 
At the root of many of these problems is China’s continued pursuit of problematic industrial policies that rely on excessive Chinese government intervention in the market through an array of trade-distorting measures.  This government intervention, evident in many areas of China’s economy, is a reflection of China’s historic yet unfinished transition from a centrally planned economy to a free-market economy governed by rule of law. As another major trade association explained in its written comments, “[t]he legacies of China’s command economy continue to be a drag on China’s complete integration into the global economy and, as a result, cause a variety of problems for China’s trading partners.”
 
During the fifteen years of negotiations leading up to China’s WTO accession, the United States and other WTO members worked hard to address concerns created by China’s historic economic structure.  Given the state’s large role in China’s economy, the United States and other WTO members carefully negotiated conditions for China’s WTO accession that would, when implemented, lead to significantly reduced levels of government intervention in the market and significantly fewer distortions in trade flows. Through the first few years after China’s accession to the WTO, China made noteworthy progress in adopting economic reforms that facilitated its transition toward a market economy. However, beginning in 2006 and continuing throughout 2007, progress toward further market liberalization began to slow. It became clear that some Chinese government agencies and officials have not yet fully embraced key WTO principles of market access, non-discrimination and transparency.  Differences in views and approaches between China’s central government and China’s provincial and local governments also have continued to frustrate economic reform efforts, while China’s difficulties in generating a commitment to the rule of law have exacerbated this situation.
 
Looking ahead, one of the critical issues for the international trading system will be to ensure that China’s leadership does not retreat from the substantial progress made to date.  Evidence of a possible trend toward a more restrictive trade regime appears most visibly in a series of diverse Chinese measures over the past two years signaling new restrictions on market access and foreign investment in China.  One trade association with broad representation explains:
 
Recent public policy debates in China have indicated a dampening of enthusiasm in some quarters for foreign participation in the economy.  Some policy makers also appear to want to expand the [Chinese] government’s role in directing the economy and in developing internationally competitive Chinese enterprises, while also restricting the role of international companies in certain sectors.  Designation of “pillar” industries, promoting “indigenous innovation,” and establishing “national economic security” criteria to review deals are troublesome signposts that do not imply full market access for U.S. companies.
 
As 2007 was drawing to a close, the United States and China were completing months of preparations for two high-level meetings scheduled to take place back-to-back in Beijing in mid- December. The first one is the annual meeting of the JCCT, chaired by Commerce Secretary Gutierrez and U.S. Trade Representative Schwab on the U.S. side and Vice Premier Wu on the Chinese side, which focuses on seeking resolutions to discrete, pressing trade issues.  That meeting will be followed by the semi-annual SED meeting, whose purpose is to manage the complex U.S.-China economic relationship on a long-term, strategic basis under the guidance of Treasury Secretary Paulson and Vice Premier Wu and with the participation of several other ministers on each side.
 
At present, several specific areas continue to cause particular concern for the United States and U.S. industry, in terms of China’s full adherence to its WTO obligations.  The key concerns in each of these areas are summarized below.
 
Intellectual Property Rights
 
Since its accession to the WTO, China has put in place a relatively good set of laws and regulations aimed at protecting the intellectual property rights of domestic and foreign right holders.  However, some critical measures still need to be revised, and China’s enforcement of its laws protecting the intellectual property rights covered by the WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (the TRIPS Agreement) has often been ineffective.  U.S. industry reports show no significant reduction in IPR infringement levels again in 2007, confirming that counterfeiting and piracy in China remain at unacceptably high levels and cause serious harm to U.S. businesses across many sectors of the economy.  Indeed, despite anti-piracy campaigns in China and an increasing number of IPR cases in Chinese courts, the U.S. copyright industries’ most recent estimates indicate that 85 percent to 93 percent of all copyrighted products sold in China in 2006 were pirated, showing little or no improvement over the previous year. USTR’s annual Special 301 report, issued in April 2007, confirmed this lack of progress, as USTR continued to place China on the Priority Watch List and subject it to Section 306 monitoring.
 
In 2007, as in prior years, the United States placed the highest priority on improving IPR enforcement in China.  The United States pursued extensive bilateral discussions with China, focusing on concrete steps that China could take to improve its legal protections and enforcement efforts so that significant reductions in IPR violations in China could be realized. These efforts achieved an agreement between the two countries’ customs authorities to cooperate on border enforcement, but other critical enforcement concerns remained unaddressed. For example, China continued to deflect calls from the United States and other WTO members for better utilization of criminal remedies to combat rampant IPR infringement in China, claiming that its approach to enforcement was showing results.  The available statistics on continuing rampant IPR infringement in China raise obvious questions about this claim.
 
In April 2007, after nearly three years of sustained bilateral engagement aimed at addressing U.S. concerns about specific deficiencies in China’s legal regime for protecting and enforcing copyrights and trademarks, the United States requested formal WTO consultations. When the ensuing consultations did not lead to an agreed resolution, the United States sought the establishment of a WTO panel to hear the case, and a panel was established in September 2007, with 12 other WTO members joining in as third parties. A panel decision is currently expected in 2008.
 
The United States remains committed to working constructively with China on a bilateral basis to significantly reduce IPR infringement levels in China and continues to devote considerable staff and resources, both in Washington and in Beijing, to address the many challenges in this area.  At the same time, when bilateral discussions prove unable to resolve key issues, the United States remains prepared to take further action on these issues, including WTO dispute settlement where appropriate, given the importance of China developing an effective, TRIPS Agreement- compliant system for IPR enforcement.
 
Industrial Policies
 
China continued to pursue industrial policies that seek to limit market access for non-Chinese origin goods and foreign service providers and offer substantial government resources to support Chinese industries and increase exports. In some cases, the objective of these policies seems to be to promote 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. In other cases, China appears simply to be protecting less competitive state-owned enterprises.
 
In 2007, examples of the trade-distortive measures implementing these industrial policies remain readily evident.  China continues to apply auto parts regulations that prolong prohibited local content requirements for motor vehicles while the WTO-consistency of those regulations is being challenged in panel proceedings at the WTO.  China is also making increasingly restrictive use of export quotas and export duties on a number of raw materials where it is the world’s leading producer. Through these export restrictions, China is able to drive up world prices while lowering domestic prices, thereby providing substantial artificial advantages to a wide range of downstream producers in China when they compete against foreign downstream producers in the China market and around the world.  In addition, even after re-committing to technology neutrality for 3G telecommunications standards at the April 2006 JCCT meeting, China’s regulatory authorities continue to promote the home-grown TD-SCDMA standard and to expand its test market.  China also continues to pursue unique national standards in a number of areas of high technology where international standards already exist, and it pressures foreign companies seeking to participate in the standards-setting process to license their technology or intellectual property on unfavorable terms.  Meanwhile, a July 2005 industrial policy that calls for the state’s management of major aspects of China’s steel industry remains in effect, and excessive government subsidization continues to benefit a range of domestic industries in China.  China has also sought to protect many domestic industries through an increasingly restrictive investment regime, as recent measures impose requirements for state control of “critical” equipment manufacturers, establish rules for foreign mergers and acquisitions that confer broad and vaguely defined powers on the government to block investments in a range of industries, and prevent further foreign investment in “pillar” industries.  Some of these industrial policy measures raise questions about China’s compliance with its WTO obligations in the areas of national treatment, market access, export restrictions, technology transfer and subsidies, among others.
 
While bilateral discussions yielded little progress in resolving U.S. concerns regarding most of these industrial policy measures in 2007, the United States was able to leverage its use of the WTO dispute settlement mechanism, as noted above, to gain China’s agreement to eliminate several prohibited subsidy programs that had been providing substantial benefits to a wide range of manufactured goods being sold in China and being exported to the United States and other markets around the world. Reached in November 2007 after months of negotiations, this agreement committed China to discontinue all of the challenged subsidies by January 1, 2008, and not to reinstate them in the future.
 
In 2008, the United States will continue to pursue vigorous bilateral engagement to resolve the serious disagreements that remain over a number of China’s industrial policy measures, including China’s highly trade-distorting use of export restrictions on raw materials.  If dialogue fails to address U.S. concerns, however, the United States will not hesitate to take further actions seeking elimination of these industrial policy measures, including WTO dispute settlement, where appropriate.
 
Trading Rights and Distribution Services
 
Many in U.S. industry consider trading rights and distribution services to be “the most important of the WTO commitments China has so far implemented,” according to one trade association with broad representation. These commitments called for full liberalization of trading rights – the right to import and export – and distribution services, including wholesale and retail services, franchising services and related services, by December 11, 2004.  With determined U.S. engagement, China has implemented these critical commitments in most sectors, and many U.S. companies and individuals are now not only able to import and export goods directly without having to use a middleman, but are also able to establish their own distribution networks within China.
 
Nevertheless, some serious problems still remain.  In particular, despite extensive and persistent bilateral engagement by the United States, China has continued to maintain import and distribution restrictions on copyright-intensive products such as theatrical films, DVDs, music, books and journals, in apparent contravention of China’s trading rights and distribution services commitments.  These restrictions reduce and delay market access for these copyrighted products, creating additional incentives for infringement in China’s market.  Once it became clear that bilateral discussions were not leading to changes to address U.S. concerns, the United States invoked the WTO dispute settlement mechanism by filing a request for formal WTO consultations in April 2007.  After two rounds of consultations in Geneva failed to resolve the dispute, the United States requested the establishment of a WTO panel to hear the case, and a panel was established in November 2007.
 
In two other key areas, the United States continued to engage China bilaterally as 2007 was drawing to a close.   First, while China has taken steps to implement its commitment to open its market for sales away from a fixed location, also known as “direct selling,” China continued to subject foreign direct sellers to unwarranted restrictions on their business operations.  In addition, China continued to discriminate against foreign retailers seeking to open new stores by making them satisfy burdensome requirements not applicable to domestic retailers. The United States will continue to pursue these important issues in 2008 to ensure that China fully meets its applicable WTO commitments.
 
Agriculture
 
U.S. agricultural exports to China in 2006 totaled more than $7.6 billion, making China the United States’ fourth largest agricultural export market.  To date, 2007 has been a comparably successful year, characterized overall by steady growth. For example, U.S. exports of bulk agricultural commodities continued to perform strongly, with soybean exports increasing dramatically.  China also remains the leading export destination for U.S. cotton, among other products.
 
While U.S. exports of agricultural commodities largely fulfill the potential envisioned by U.S. negotiators during the years leading up to China’s WTO accession, trade with China in the agricultural sector remains among the least transparent and predictable of the world’s major markets, as it continues to be plagued 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 SPS measures 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 agricultural trade.
 
In 2007, the principal targets of questionable practices by China’s regulatory authorities were poultry, pork and soybeans, and anticipated growth in U.S. exports of these products was impeded. In addition, China continued to block the importation of U.S. beef and beef products, even after these products had been declared safe to trade under international guidelines.
 
In 2008, the United States will continue to pursue vigorous bilateral engagement with China in order to obtain progress on its outstanding concerns. The United States also will not hesitate to take other actions to resolve its concerns if dialogue fails.
 
Services
 
Overall, the United States enjoyed a substantial surplus in trade in services with China in 2006, as in prior years, and the market for U.S. service providers in China remains promising. However, in some sectors, it appears that China’s commitments to increase market access and remove restrictions have still not been fully realized. Chinese regulatory authorities continue to frustrate efforts of U.S. providers of banking, insurance, telecommunications, construction and engineering, legal 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 2007, U.S. engagement through the SED meeting in May led to some limited progress.  China committed to eliminate the backlog of U.S. non-life insurers’ applications for conversion from a branch to a subsidiary, and it followed through on that commitment.  In addition, China committed to act on the applications of foreign banks incorporated in China seeking to issue their own domestic currency credit and debit cards, although it has not yet done so, hindering the banks’ ability to attract Chinese individuals as new customers.  China has also failed, to date, to fulfill a commitment that it made at the April 2006 JCCT meeting to lower excessive capital requirements that have been blocking market access for foreign providers of basic telecommunications services.
 
Meanwhile, two serious WTO concerns that arose in 2006 have so far resisted resolution through high-level bilateral engagement.  In particular, Xinhua, the Chinese state news agency, persisted in its refusal to withdraw rules issued in September 2006 imposing new restrictions on foreign providers of financial information services, raising questions about China’s implementation of specific WTO commitments that it had made.  In addition, questions were raised about China’s failure to implement important commitments scheduled to be phased in by December 11, 2006, which would allow foreign credit card companies to provide electronic payments processing services for domestic currency transactions.
 
In 2008, the United States will continue to engage China and will closely monitor developments in an effort to ensure that China fully adheres to its services commitments. If necessary, the United States also will not hesitate to take further actions seeking to enforce China’s WTO commitments, including WTO dispute settlement, where appropriate.
 
Transparency
 
One of the fundamental principles of the WTO Agreement, reinforced throughout China’s WTO accession agreement, is transparency. Transparency 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 made important strides to improve transparency across a wide range of national and provincial authorities during the first four years of its WTO membership. However, two shortcomings stood out.  As of December 11, 2005, China had still not adopted a single official journal for publishing all trade-related measures, and it had yet to regularize the use of notice- and-comment procedures for new or revised trade-related measures prior to implementation.  In 2006, after the United States elevated this issue to the JCCT level, China finally adopted a single official journal, although much work remains for China to ensure full participation by all relevant government entities.  The United States has also pushed China to adopt a mandatory notice-and- comment practice, and this issue will be a key topic for discussion at the SED meeting taking place in December 2007. To date, however, notice-and-comment remains an optional practice in China.  As a result, many of China’s regulatory regimes continue to suffer from systemic opacity, frustrating efforts of foreign – and domestic – businesses to achieve all of the potential benefits of China’s WTO accession.
 
Conclusion
 
In 2008, the Administration will continue its concerted efforts to ensure that China fully implements its outstanding WTO commitments and fully adheres to its fundamental obligations as a WTO member, with particular emphasis on reducing Chinese government intervention in the market, lowering IPR infringement levels in China and making China’s trade regime more predictable and transparent.  Throughout this process, the Administration will continue to solve problems with dialogue if possible, legal action when necessary, and work within the rules-based international trading system.  The Administration will continue to work cooperatively and pragmatically with China – through the robust set of formal and informal U.S.-China bilateral dialogues and meetings, including the JCCT and the SED – to ensure that the benefits of China’s WTO membership are realized by the United States and the world and that problems in our trade relationship are appropriately resolved.  When bilateral dialogue is not successful, however, the Administration will not hesitate to employ the full range of enforcement tools available, whether it be the dispute settlement mechanism at the WTO or the enforcement of U.S. trade laws – under the WTO’s rules-based system – to ensure that U.S. interests are not harmed by unfair trade practices.

 

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