U.S.-China Economic and Security Review Commission, "Hearing: China's Investment and Exchange Rate Policies - Impact on the U.S.," September 25, 2003

September 25, 2003
Room 124, Dirksen Senate Office Building,
1st & Constitution
Washington, DC

DEAR SENATOR STEVENS AND SPEAKER HASTERT:

On behalf of the U.S.-China Economic and Security Review Commission, we are pleased to transmit the record of our hearing on September 25, 2003, on ‘‘China’s Industrial, Investment and Exchange Rate Policies: Impact on the United States.’’ These issues are at the forefront of U.S.-China economic relations, particularly in light of the impact that China’s exchange rate and industrial policies are having on global investment trends and on U.S. manufacturing and trade deficits. We are aware that both the Executive Branch and Congress are examining initiatives to address U.S. concerns in this area and therefore we outline here several of the Commission’s key findings and recommendations arising from our hearing and research activities to help inform Congressional deliberations.

As you know, the Commission is mandated by law (P.L. 108–7, Division P) to examine, among other areas, China’s economic policies and the United States trade and investment relationship with China, including assessing the qualitative and quantitative nature of the shift of United States production activities to China. This latter charge includes examining the relocation of high-technology, manufacturing and R&D facilities to China and the effect of these transfers on United States economic security, employment and the standard of living of the American people.

At our September 25 hearing, the Commission heard testimony from a number of Members of both the House and Senate, including the principal sponsors of various Congressional initiatives designed to address China’s exchange rate practices. Representing bipartisan Congressional concerns, these Senators and House Members have introduced differing bills aimed at providing appropriate incentives to the Chinese government to end its apparent mercantilist trade policies, most particularly its artificially undervalued currency, as well as other unfair trade practices such as export subsidies, dumping, and other WTO-inconsistent practices. The Members testified that such practices by China amounted to a forced redistribution of trading and investment balances that violate the principles of free and fair trade embodied in China’s WTO accession obligations as well as in its bilateral trade arrangements with the United States and other international agreements, such as the IMF charter. One result of China’s unfair trade practices has been its rapid accumulation of foreign exchange reserves, now totaling some $355 billion, the second highest in the world after Japan.

Exchange rate policies. Based on our examination of this issue, it appears clear that China continues to follow a policy of one-way market interventions by the government to maintain its currency at a level that economists estimate is between 15–40 percent undervalued. In this regard, China is purchasing U.S. dollars at an estimated rate of $120 billion per year to prevent appreciation of its currency against the dollar. In assessing causes of the worsening U.S. trade deficit and loss of U.S. manufacturing jobs, some hearing witnesses argued that the lack of net new savings in the U.S. economy, the global mobility of factors of production and/or low labor costs in China were the principal factors. In any event, based on the evidence presented, we believe the inappropriate exchange rate between the Chinese yuan and the dollar is negatively impacting the competitiveness of U.S. manufactured goods and is contributing to a migration of world manufacturing capacity to China and an erosion of the U.S. manufacturing base.

Section 3004 of the Omnibus Trade and Competitiveness Act of 1988 (22 U.S.C. Sec. 5304) requires annual reports from the Department of Treasury on foreign countries’ exchange rate policies and requires the Secretary to enter into negotiations on an expedited basis with countries found to be manipulating their currencies to gain an unfair competitive trade advantage. Past reports from the Treasury on China have sidestepped this conclusion, which appears now to be inescapable. The Commission believes it is clear that China, in violation of both its IMF and WTO obligations, is in fact manipulating its currency for trade advantage and therefore finds it imperative that the Treasury immediately and forcefully enter into negotiations with the Chinese government to resolve this matter. China’s continued maintenance of an undervalued exchange rate with the U.S. dollar will continue to promote major distortions in the flow of trade and investment, to the detriment of American companies and workers, and therefore requires decisive action by Washington.

Recommendation: The Treasury Department should make a determination in its foreign country exchange rate report to Congress that China is engaged in manipulating the rate of exchange between its currency and the U.S. dollar to gain an unfair competitive trade advantage and immediately enter into formal negotiations with the Chinese government over this matter. Should these efforts prove ineffective, the Commission urges the Congressional leadership to use its legislative powers to force action by the U.S. and Chinese governments to address this unfair and mercantilist trade practice. For the near future, continued vigorous development of such legislative initiatives as were outlined by Members of Congress during our hearing, linking China’s performance on its exchange rate policies to its continued full access to the U.S. market, appears essential to ensure the appropriate level of effort by both governments to this matter.

China’s Investment and Industrial Policies. China has attracted a total of over $400 billion of foreign direct investment (FDI), most of it in the last six years. This compares with $1.3 trillion for the U.S., $497 billion for the U.K., $482 billion for
Belgium-Luxemburg, and $480 billion for Germany. As FDI flows to China are now expanding by over $50 billion per year, China will soon have accumulated the second largest stock of FDI in the world.

Our hearing indicated that China’s undervalued currency is just one of several factors behind that country’s success in attracting massive inflows of FDI, particularly into its manufacturing sector. Our hearing examined the extent to which China’s industrial policies have played a role. In this regard, we learned that:

• China has pursued industrial policies that have catalyzed its growth as a manufacturing powerhouse, particularly in increasingly higher-technology production. The Chinese government has designated a number of ‘‘pillar industries’’ and pursued a strategy of ‘‘picking winners’’ among China’s emerging high-tech or industrial enterprises.
• Manufacturers in China are supported through a wide range of national industrial policies, which include: tariffs; limitations on foreign firms’ access to domestic marketing channels; requirements for technology transfer by foreign investors; government selection of partners for major international joint ventures; preferential loans from state banks; privileged access to listings on national and international stock markets; tax relief; privileged access to land; and direct support for R&D from the government budget.

Recommendation: The United States Trade Representative and the Department of Commerce should identify whether any of China’s industrial policies are inconsistent with its WTO obligations and engage with the Chinese government to mitigate those that are significantly impacting U.S. market access. Appropriate Congressional Committees should be fully briefed on the actions the agencies are taking to resolve these issues.

Recommendation: The Commission believes it is essential that U.S. policy-makers have a clearer, more comprehensive, and timely picture of global investment and R&D flows to China, particularly in the manufacturing sector. The Commission’s 2002 Report to Congress urged Congress to consider establishing an enhanced, mandated corporate reporting system to capture better this information by requiring firms to report ‘‘their initial investments in China; any technology transfer, offset, or R&D cooperation agreed to as part of the investment; the shift of production capacity and job relocations resulting from the investment, both from within the United States to overseas and from one overseas location to another; and contracting relationships with Chinese firms.’’ We believe the need for such a system has only increased in urgency since our 2002 Report and again urge Congress to consider taking such action.

Impact on U.S. Economy. In his September 15, 2003 prepared remarks at the Detroit Economic Club, Commerce Secretary Don Evans reports that ‘‘the President believes that our economic and national security require a stable, robust manufacturing sector that produces sophisticated and strategically significant goods here, in the United States.’’ Manufacturing employs 14 percent of the American workforce, but has accounted for nearly 90 percent of all the job losses since total U.S. employment peaked in March 2001. Over 2.7 million American factory jobs have been lost over the past three years, roughly one in every six manufacturing jobs.

At our September 25th hearing the Commission heard testimony that supported a conclusion that China’s undervalued currency and government investment strategies are having a deleterious effect on the competitiveness of U.S. manufactured goods and contributing to a migration of world manufacturing capacity to China, with a concurrent erosion of the U.S. manufacturing base.

Recommendation: The Commission believes that the President’s pending Manufacturing Initiative should include provisions that strengthen the competitiveness of U.S.-based manufacturers in light of the growing shift of production to China, especially high-tech and R&D. The Initiative should address de facto Chinese government subsidies, particularly those not covered under the WTO, such as tax incentives, preferential access to credit, capital, and materials, and investment conditions requiring technology transfers.

It is the hope of the Commission that the results of this hearing will contribute to the fashioning of legislation by the Congress which will help to illuminate the economic impact that China is having on U.S. producers, better identify unfair Chinese trade practices, and steer Chinese economic practice into more sustainable and fairer channels.

Yours truly,

Roger W. Robinson, Jr.
Chairman

C. Richard D’Amato
Vice Chairman

OPENING REMARKS
Opening Statement By Hearing Chairman Roger W. Robinson, Jr.
Opening Statement By Vice Chairman C. Richard D’Amato
Opening Statement By Co-Chair June Teufel Dreyer
Opening Statement By Hearing Co-Chair Patrick A. Mulloy

U.S. Senators and Representatives
Senator Byron L. Dorgan (D-ND)
Senator Lindsey Graham (R-SC)
Representative Sander (Sandy) M. Levin (D-MI)
Representative Donald A. Manzullo (R-IL), Chairman, House Small Business Committee
Senator Charles E. Schumer (D-NY)
Senator Olympia J. Snowe (R-ME)
Representative Charles Stenholm (D-TX)
Representative Phil English (R-PA)
Hon. C. Fred Bergsten, Ph.D., Director, International Institute for Economics
David Hale, Chief Economist and Founder, Hale Advisors, LLC
Thea Lee, Chief International Economist, AFL-CIO
Peter Hugh Nolan, Ph.D., Sinyi Professor of Chinese Management, University of Cambridge
Ernest Preeg, Ph.D., Senior Fellow, Manufacturers Alliance
Stephen Roach, Ph.D., Chief Economist, Morgan Stanley
Edward Steinfeld, Ph.D., Associate Professor of Political Science, MIT
Kathleen (Kate) Walsh, Senior Associate, Stimson Center
Willard Workman, Senior Vice President, International Division, U.S. Chamber of Commerce
Frank Vargo, Vice President for International Economic Affairs, National Assochtt of Manufacturers
Hon. Paul Craig Roberts, Ph.D., Chairman, Institute for Political Economy; Former Asst. Sec. of the Treasury for Economic Policy