The end of 2008 could be a momentous time for Sino-American
commercial relations. A new U.S. President will take the reins just
after the 30th anniversary of China's market reforms. Natural
attention is being given to what the new President plans for the
Strategic Economic Dialogue (SED) and other elements of the
But the 30th anniversary marks a more important development to
the future of these negotiations. Reform began 30 years ago-about
three years ago, it stopped.
Since the present Chinese leadership took power in late 2002,
market-oriented reform has been minor, resting on a legacy of
earlier decisions. As market-oriented policies wind down, they are
increasingly supplanted by state-run development. The last few
years have been characterized by price intervention, absence of
privatization, rollback of competition, and fresh investment
By most economic standards, however, the state has done very
well. Success has created a constituency, moving Beijing
dangerously close to an obsession with growth at the expense of all
else. It presently does not see a strategy of further genuine
market-oriented reform as in its long-term interest. Whatever the
objectives of the new U.S. Administration, it must surmount
this frame of mind. While true broad-based market-oriented reform
should remain as a goal and context for American economic policy
toward the People's Republic of China (PRC), the next
Administration's economic diplomacy would do best to focus
negotiating objectives on an evaluation of actual Chinese
development strategy of rapid and state-led growth. American
policies that presume ongoing market reform will be flawed from the
One response is to dismiss the whole endeavor of economic
engagement with China. That would be a high-stakes gamble. The U.S.
and China combined accounted for more than 30 percent of gross
domestic product (GDP) worldwide last year. Bilateral trade
volume between the two countries stood at $387 billion, dwarfing
the $208 billion between America and Japan. Chinese exports to the
U.S. were the equivalent of approximately 9.5 percent of Chinese
GDP in 2007 while its holdings of U.S. treasuries were more than
$500 billion at the end of June 2008. This is the most
important bilateral economic relationship in the world. Even
incremental improvement in its structure would have a large
With this in mind, the question is how to engage
China. The answer depends first on the new President's
viewpoint on trade. The advantages of free trade are apparent both
in the abstract and tangibly. At its core, free trade offers
opportunities and choices to businesses and consumers, while
protectionism limits both. It would be especially difficult in
the current economic environment for a President to move
sharply away from open trade: Surprisingly vigorous
second-quarter GDP growth this year was driven almost entirely by
trade. It is thus quite unlikely that the
new President will simply abandon economic dialogue with the
Fortunately, while the substantive ground has shifted, the
existing institutional framework for Sino-American economic
relations, topped by the SED, is generally sound. Retaining the SED
or an equivalent arrangement offers a superior path to progress in
bilateral talks, though the location of U.S. negotiating authority
should be changed from the Secretary of the Treasury to the Vice
President. This makes changes in U.S. policy relatively easy to
Under the circumstances, the best action that the U.S. can take
is to encourage the Chinese to move in the right direction by
focusing on a narrow range of reform that is feasible in the
present context. The changes proposed here feature steps toward
long-term price liberalization, curbing state dominance at the
corporate level, shielding American companies from
mercantilist "reforms," and restarting the process of opening the
capital account to allow money to move freely in and out of the
The End of Reform
The June 2008 meetings of the SED in Annapolis,
Maryland,emphasized energy, environmental cooperation, and the
start of challenging talks on a bilateral investment accord.
According to Secretary of the Treasury Henry Paulson, the December
2008 meetings will focus on the same topics. One issue is
whether the next President should retain, modify, or drop the SED
as the executive branch's negotiating framework. The more
important subject, of course, is what the SED or its replacement is
intended to accomplish. Here, a significant shift in American
policy is required.
The heart of the matter is that the new President must re-orient
U.S.-China trade policy in light of Chinese disinterest in
meaningful talks on issues such as subsidization of state
enterprises. That disinterest stems from an apparent decision
by President Hu Jintao and Premier Wen Jiabao to halt
market-oriented reform. As for the substance of the negotiations,
energy, environment, and bilateral investment are fine topics, but
the agenda should be restructured to emphasize a series of
meaningful market reforms.
In 1998, then-President Jiang Zemin and then-Premier Zhu Rongji
ordered that investment by state entities be pushed much higher.
This was in response to a genuine slump induced by the 1997 Asian
financial crisis and emerged while China was offering important
market reforms during World Trade Organization (WTO) talks. There
has been no equivalent slump since, yet the Hu-Wen
administration has relentlessly advanced the public role in
the economy. With WTO concessions largely implemented by 2005,
the state's advance has been forcing the market's retreat.
Though he is a devout optimist, Secretary Paulson
acknowledges that "China's leaders today are committed to reform,
at least so long as it improves the country's political and
economic stability." In fact, even this is not true,
unless a very dubious definition of "reform" is accepted
Arguing that reform is frozen or worse may be controversial
among those who assume that China has been moving forward all the
while, but overwhelming evidence that reform has stopped is
being ignored. There have been setbacks in price
liberalization, the core of market reform. Privatization was
first stalled, and then explicitly rolled back. Corporate
competition is also being rolled back. Even the relatively open
external sector is not immune to an increasing state role. Ignoring
these developments will leave any U.S. dialogue with China an
exercise in futility.
There was outstanding progress in liberalizing prices during the
first two decades of reform, perhaps its crucial feature. This
has been halted and, recently, reversed by the central government.
The price of labor-wages-is largely free from government
interference. But that is manifestly not true of the price of
capital-the interest rate. All interest rates are confined
within ranges set by the People's Bank. Prices for basic assets,
such as land, are constantly distorted by government
intervention. The price of foreign currency-the
exchange rate-has been loosened in the past three years, but the
daily setting of parity by the People's Bank still dictates its
direction. There are stark limits on the extent of movement. Daily
movement of the yuan against the dollar, for example, can be no
more than 0.5 percent.
There is also bad news elsewhere. Prices for all key services
are managed by the State Council. This includes not only utility
bills and the cost of health care, but also education and
Finally, it is commonly understood that sales prices of ordinary
goods are set by the market. This has never been entirely true, and
the tendency over the past few years has been to extend, not
retract, the reach of price controls for goods. Complete state
control of grain distribution has always distorted wholesale grain
prices; the recent bout of inflation has prompted retail food price
restrictions as well. Energy has also always been tightly
held. New price levels mandated this year are merely business as
usual in coal and oil products, such as gasoline.
Privatization Is Dead
There certainly has been privatization of Chinese state assets
during the reform era. But it has never been extensive and, in the
third decade of reform, it has faded. The number of individuals who
own businesses fell 15 percent to 26 million from the end of 2005
to the end of 2006, a pittance in such a large population. Official data show that truly
private companies contributed less than 10 percent of tax
revenue in the first nine months of 2007 and that the private
sector's proportional contribution is actually beginning to drop.
The "truly private" aspect is important because privatization
has become confused with the spread of a shareholding structure and
sales of minority stakes. In such cases, 100 percent state
ownership is diluted by dividing ownership into shares and
making some available to non-state actors such as foreign
companies or retail stock investors. Nearly two-thirds of
state-owned enterprises and subsidiaries have undertaken such
changes. Some foreign observers
reclassify these firms as "non-state" or even "private." This
reclassification is incorrect, conceptually and practically.
Conceptually, the sale of stock does nothing by itself to alter
state control: For instance, dozens of centrally directed
enterprises are no less state-owned simply by being listed on
foreign stock exchanges (e.g., Guodian Power, an electric
company which has a Hong Kong-listed subsidiary). As a
practical matter, three-quarters of roughly 1,500 companies listed
as domestic stocks are still state-owned. It is also true that
state enterprises and the government share the same pool of
officials. It is routine for Chinese officials to repeatedly bounce
back and forth from corporate to government posts, each time at the
behest of the Party.
No matter their shareholding structure, all large corporations
in sectors that make up the core of the economy are required to be
state-owned. The list of sectors that must by law be
state-controlled is impressive:
[T]he State should solely own, or have a majority share in,
enterprises engaged in power generation and distribution, oil,
petrochemicals and natural gas, telecommunications and
armaments. The State must also have a controlling stake in the
coal, aviation and shipping industries.... Central SOEs
[State-Owned Enterprises] should also become heavyweights in
sectors including machinery, automobiles, IT, construction, iron
and steel, and non-ferrous metals.
Remarkably, that is not exhaustive. Rail, grain distribution,
and insurance are dominated by the state, for example, even if no
edict was issued to that effect.
Moreover, the state exercises control over most of the rest of
the economy through the financial system, especially its
banks. The outstanding stock of loans was more than $4 trillion and
annual growth more than 14 percent in the first half of 2008,
making lending perhaps the principal economic force. All large
financial institutions are state-owned, the People's Bank assigns
them loan quotas every year, and, within these quotas, lending is
directed according to the state's priorities.
The central bank's loan quotas frustrate non-state borrowers.
They might try to raise funds through bond or stock sales, but
these are also dominated by the state.The volume of government bond
issuance is more than a dozen times that of corporate bonds and is
growing relentlessly, crowding out private firms. In stocks, a
purported solution to the huge quantity of non-traded state shares
launched domestic stocks on a wild bull run in 2006 and 2007. That solution relied on keeping
non-traded state shares locked up for three years. With the
lock-ups starting to expire, state shares again loom large over the
market and share prices have come crashing back to earth.
Competition Is Wounded
One reason the dearth of reform has been overlooked is that
China is engaged in a process of "restructuring." Unfortunately,
"restructuring" has none of the characteristics of market reform.
It is aimed at shrinking the number of participants in many
industries, expanding the size of the remainder, and thus reducing
competition on both counts.
Japan and Korea have previously developed a model of national
champions-large corporate groups consciously created with the idea
that size is necessary to compete globally. An unspoken
corollary is often that neither domestic nor foreign competition
with these champions can be tolerated. China has been enamored of
the champions concept for at least a decade, but the restructuring
process was accelerated in 2002 with the ascent of Hu and
Results are striking. A plan for central state enterprises
to pay dividends to the Ministry of Finance has been tentatively
adopted. The dividend requirement was imposed on the oil and
petrochemicals, gas, coal, power, telecom, and tobacco industries.
There were only 18 firms involved in the six sectors in the
beginning. Now there are 17, as the
number of national telecom entities was shrunk from four to
three, reversing the break-up of China Telecom under the
It is hardly just the telecom industry that is affected. First
Aviation Industry and Second Aviation Industry are
merging-apparently two firms are too many. Managed
consolidation is occurring from cement to retail.
Where market concentration is already very high, the National
Development and Reform Commission (NDRC) seeks to guard
against any relapse. Rather than permitting competition to drive
down windfall crude profits and drive out inefficient oil product
suppliers, the NDRC hiked taxes for crude on the three state oil
giants-which constitute the entire crude industry-and subsidized
the three companies in oil refining, where they face small
competitors. This had the extra benefit of
ensuring that state involvement is central to all oil-related
activity, so that the suppression of competition fits perfectly
with suppression of privatization.
Trade and Investment
More trade and inward investment would be a step toward domestic
economic freedom, but foreign investment has faced mounting
barriers since economic nationalism began to intensify in late
2005. This seems to fly in the face of
strong inward direct investment this year but the gains are a
mirage. In the first five months of 2008, while official
foreign direct investment (FDI) leaped 55 percent, investment
in fixed assets, where the spending is tangible, declined by 4
percent. The Chinese press is well aware that increasing FDI is
largely for purposes of financial speculation rather than
developing new technology or creating high-quality jobs.
True multinational corporations interested in investing in the
PRC have seen WTO-inspired hopes dashed. The greater market access
required by a proposed U.S.-China bilateral investment treaty is
undercut by the regression in market access over the past three
years. The curtailing of access dates back to the Carlyle Group's
original attempt to acquire Xugong Construction Machinery. Barriers against foreign investment
in real estate followed shortly thereafter. In 2007,
Beijing announced national security restrictions on FDI, including
restrictions on acquiring any "famous" domestic brand, whereby the
Chinese government decides what is famous. When stocks
were soaring, foreign bids were said by regulators to
undervalue domestic companies. Now that share
prices have collapsed, deals are blocked nonetheless.
Two new significant laws enacted in 2008, touted as "reforms,"
appear principally to be weapons against foreign companies.
Implementation of one, the Labor Law, is in the hands of a
xenophobic Party organ, the All-China Federation of Trade
Despite its name, the other, the Anti-Monopoly Law will not
promote competition. It is designed to protect "public interest
and…the healthy development of the socialist market
economy." It forbids dominant firms from buying or selling at
"unreasonable" prices, yet offers no method to identify what
is unreasonable. It fails to define a market.
Most telling, the Anti-Monopoly Law contains an exception for
all industries controlled by the state, as well as any industries
deemed important to national security. It also provides for a
national security review of foreign acquisitions in addition
to theantitrust probe. The notion of screening proposed
acquisitions on national security grounds is not unusual-many
countries do so-but the Communist Party's definition of
"security" is exceptionally broad. In light of the long list of
industries that must be controlled by the state,these provisions
can include essentially everything. State monopolies will remain
Multinational corporations face multiple threats. The first
monopoly claim with the Ministry of Commerce was filed against
Microsoft. Perhaps most distressing,
intellectual property rights (IPR) can be terminated if they are
deemed abused in connection with a monopoly. China has long
considered many patents unfair and now has legal means to act. The
law could be wielded to retaliate against IPR enforcement attempts
such as the case brought by the U.S. to the WTO against China. It
could be used as a new way of undermining IPR if the WTO rules
Trade is largely open and competitive on the export side.
Imports still face some non-tariff barriers for the sake of
protecting state prerogatives. As usual, vital industries such as
energy and agriculture are sheltered.
The main point of contention, of course, has been the exchange
rate. As mentioned, the exchange rate is controlled as part of all
financial prices set by the State Council. A push for exchange-rate
liberalization, however, will present America's new
President with a clear trade-off: Curbing Chinese state control may
not favor the U.S.
After the inauguration of more rapid exchange-rate movement with
the 2.1 percent revaluation in July 2005, the yuan climbed an
additional 16 percent against the dollar by the end of August
2008. Over the same period, the yuan fell 2 percent against the
euro. While it is probably still overvalued against the
dollar, the yuan is far more overvalued against other
currencies. A wider daily band in which the value for the yuan can
move in an authentic, trade-weighted basket of currencies could
very well lead to short-term depreciation against the dollar. In
the long term, a freer exchange rate is in American interests, but
the next Administration should be careful what it wishes for.
There is another avenue to pursue on the trade side, though.
During WTO accession, it was believed that the difficult process of
liberalizing the capital account-letting money move freely in and
out ofthe country-would move in tandem with implementation of WTO
concessions. An open capital account was to be ratified not
later than the 2007Communist Party Congress. Instead, under the
Hu-Wen regime, there has been little progress, and perhaps
regression. Part of this is
understandable: The State Administration of Foreign Exchange
has been plagued the past three years by funds pouring into the
country. Even before that, however, Beijing showed little
interest in allowing multinationals, and certainly not its own
citizens, to send earnings or savings freely out of the
The obvious benefit of capital-account liberalization is
unfettered repatriation of profits by foreign investors. As such,
the U.S. business community has long been an advocate. There is
also a more subtle, more important gain for the offering. The
state intervention in the economy documented above would be
considerably reduced if financial policy had to account for a
market reaction. An open capital account would permit capital
to exit, constraining bank behavior. This would, in turn,
inhibit the state-directed lending that has effectively blocked
privatization and subverted competition. An open capital account is
still far in the future, unfortunately, but it is a prize
The Growth Obsession
Contributing directly to the death of reform is the pursuit of
GDP growth at the expense of all else. In recent years, the
Communist Party has used rhetoric suggesting growth was no
longer the primary objective. The words were
followed by yet faster growth. As the economy returns to its
previous speed, growth has once again been formally elevated
above all other objectives. The apparent mandate
that the economy expand by at least 10 percent annually sharply
limits, among other things, the potential for bilateral cooperation
in ecology and energy.
There would be little discussion of commercial negotiations with
China were it not for its brilliant economic performance over the
past three decades. The last six years, in particular, have brought
gravity-defying growth and the emergence of China as a truly
global economic actor.
These six years coincide with the arrival of the Hu-Wen
administration. It is routine for a newChinese regime to buy the
affections of provincial leaders by initially boosting growth. Hu
and Wen, however, have extended the standard of one to two years to
an extreme six.
China's GDP has more than tripled in dollar terms over the past
six years and nearly tripled in yuan terms. The 10.4 percent gain
in the first half of 2008 is considered slow. More telling, the
purpose of rapid GDP growth has been to create jobs and it has been
successful. The registered urban unemployment rate was stable at 4
percent by the end of June, excelling an already ambitious target
of 4.5 percent. (That figure greatly understates true
joblessness, but may be accurate with respect to trend.) This has allowed millions of
migrating rural workers to be absorbed into the urban labor
At the same time, urban wages have managed to climb
significantly. On official data, urban salaries were said to
increase by 18 percent from the first half of 2007 to the first
half of 2008, considerable even after inflation. The payoff
is demonstrated in retail sales growth of 21 percent (again
unadjusted for inflation). Exports have been the subject of
much gnashing of teeth, but expanded by more than 20 percent
in dollar terms in the first half. The trade surplus declined, but
this is due to global oil prices. The non-oil trade surplus
There are drawbacks to six years of furious expansion, of
course. The most pointed one at present is that soaring food prices
for consumers have been replaced by soaring energy prices for
producers. And official results understate
inflationary pressure because energy price controls have
always been in place and were recently extended to food. Producer
price inflation will be felt by consumers over at least the next
year, though this may not be evident in a poorly constructed
consumer price index.
GDP growth has exceeded double digits, job creation has
surpassed its target, and inflation has spiked. All the while,
fiscal and monetary policies have remained intensely expansionist,
despite loud pronouncements to the contrary. At the growth peak in
2007, monetary policy actually became increasingly loose. When the
pace of GDP moderated in 2008, there was a rush to fiscal
In 2007, inflation-adjusted "real" interest rates began to turn
negative, the ultimate sign of perverse monetary policy. Interest
rates turned more starkly negative in the first quarter of this
year. The benchmark one-year interest rates set by the
People's Bank for borrowing and saving remained fixed despite
considerable inflation. At the end of June 2008, official
consumer and producer price inflation were both close to 8 percent
while the return on a one-year deposit was barely 4 percent. The
inter-bank market hosts the lion's share of financial
transactions, though it is overrun by government bonds with
fixed prices. The January 2008 inter-bank bond yield was 2.81
percent. After six months of purported monetary contraction, the
July inter-bank bond yield was 2.76 percent.
With consumer inflation beginning to ebb, real interest rates
will become less distorted than before. But this coincides with
additional loosening of the fiscal taps. China's urban fixed
investment jumped nearly 27 percent in the first half of this year
and accelerated further in July. "'We need to
actively boost domestic demand, to maintain steady economic
growth,' said [the Chinese Academy of Social Sciences'] Wang
Tongsan. 'Investment is an indispensable part of boosting
domestic demand.'" This sounds reasonable, except that
the baseline from which "domestic demand" must be boosted features
10 percent GDP growth and the means of doing the boosting is urban
investment growth which already exceeds 25 percent.
This is the correct light in which to view cooperation with
Beijing on energy and ecological concerns. China certainly
needs to protect its environment and thus wants to diversify its
energy sources. Neither of these bars the terrible distortion of
the financial system and 27 percent investment gains-which finance
the very production that drains energy and other resources and
depletes the environment, but are deemed necessary because GDP
growth is "only" 10.4 percent.
The minor increases in energy efficiency and slower rates of
environmental degradation over the last few years will, therefore,
continue to be overcome byeconomic growth. This is evident
most clearly in coal use. Beijing has spent lavishly on nuclear,
gas, and wind power in an attempt to diversify energy sources.
The government has tried to close small coal mines for
environmental and safety reasons. Yet coal production went from 525
million tons in the first half of 2002 to a staggering 1.26 billion
tons in the first half of 2008. Now, the State
Council has switched back to emphasizing greater coal output.
The Best Institutions
Chinese economic performance is largely beyond the control of
the next U.S. President. What he and his senior staff can control
is how to engage the Chinese government. The existing
institutional frame is the SED, created by order of
President Bush and President Hu in September 2006. The SED
houses an increasingly ungainly series of high-level interactions
between U.S. and Chinese institutions:
- The Joint Commission on Commerce and Trade (JCCT) between the
U.S. Department of Commerce, the U.S. Trade Representative,
and China's Vice Premier responsible for trade;
- The Joint Economic Committee between the U.S. Department of the
Treasury and the Chinese Ministry of Finance;
- The Joint Commission on Science and Technology between the
U.S. Director of the Office of Science and Technology Policy and
the Chinese Ministry of Science and Technology;
- The Economic Development and Reform Dialogue between the
U.S. Department of State and China's National Development and
- The Energy Policy Dialogue between the U.S. Department of
Energy and China's National Development and Reform
- The Global Issues Forum led by the U.S. Department of
State and China's Ministry of Foreign Affairs; and
- The Healthcare Forum between the U.S. Department of Health
and Human Services and the Chinese Ministry of Health.
This clutter is a natural by-product of the world's two largest
economies coming to grips with each other. There are so many issues
and sectors to be covered, the clutter alone suggests the need for
an overarching mechanism like the SED. There is also the more
concrete problem of harmonizing objectives among Cabinet
departments. China and the U.S. have both common and clashing
interests in trade, investment, energy, ecology, health, and
scientific research, suggesting exchanges between such
disparate agencies as America's Health and Human Services and
China's new Ministry of Environmental Protection.
Even limiting the discussion to traditional economics still
entails the JCCT, the Joint Economic Committee, and the Economic
Development and Reform Dialogue, involving the U.S. Departments of
Commerce, State, and Treasury and the USTR on one side, and a
Chinese delegation headed by a vice premier and including the
Ministries of Commerce and Finance and NDRC on the other. Single
issues also run across department lines. American desires for
Chinese capital-account liberalization, for example, would see
Commerce, Treasury, and USTR in talks with the Ministry of
Commerce, People's Bank, and NDRC.
Economic dialogue with China will continue to be difficult.
Opportunities might be missed if there is no framework in which to
coordinate the objectives of different departments and no
higher authority to offer trades across issues that, when
taken individually, appear to be intractable. Even if the new
President decides on a more direct, aggressive approach, it would
be an advantage to be able to raise the stakes from the energy
policy dialogue, for example, to the SED or something similar.
The SED or an equivalent should, and probably will, survive the
transition to a new Administration. Treasury's leading role may not
survive, though, as this can undercut the principal benefits of the
First, a higher vantage point than that of a Cabinet
secretary is needed to discern where progress can be made.
Second, a Cabinet secretary's obvious counterpart is a
Chinese Cabinet minister, relatively low in the Communist Party
hierarchy. U.S. efforts have led to the routine inclusion of a vice
premier on the Chinese side, but it would be ideal if the premier,
as head of the State Council and thus of all bureaucracies
involved, would take the lead. The American side would then need to
be represented by the Vice President, but only if he or she has
real authority to negotiate. Otherwise, an especially powerful and
trusted Cabinet secretary-from the Treasury, Commerce, or
State Departments-should be given an additional title pertaining to
economic policy or China in order to encourage the permanent
assignment of a vice premier with sufficient authority to make
What the U.S. Should Do
- The lead American negotiator should ask his counterpart for a
long-term, explicit, commitment to broad price liberalization,
including interest and exchange rates. This will be valuable when a
future slump leaves Beijing more willing to listen.
- The next U.S. Administration should press for partial energy
price liberalization in China when the latter's energy inflation
calms. There is a domestic constituency favoring price
liberalization, and it would serve to check energy
consumption and preserve the environment.
- Rather than waste calls for privatization on this particular
unwilling audience, the Administration should emphasize the
possibility of WTO complaints over state involvementunless the
central government's support for state-controlled "shareholding"
firms is made transparent.
- The Administration should seek a formal, long-term commitment
that each consolidated, state-dominated sector be opened to foreign
participants, even if the Chinese side insists on some limits
to the latter.
- The Administration should emphasize that discriminatory
application of the Labor Law is not acceptable. It also should
demand modification of the Anti-Monopoly Law to eliminate the
threat to intellectual property.A WTO complaint on the extent of
state exclusions from the Anti-Monopoly Law can serve as leverage.
A comprehensive bilateral investment accord should be placed
on hold as unfeasible.
- The Administration should switch emphasis from exchange-rate to
capital-account liberalization, asking for a long-term
schedule of steps the Chinese government will commit to in opening
the capital account.
- The Administration should downgrade priority of environmental
agreements that threaten China's economic growth.From the U.S.
side, such agreements are considered clear mutual
interests.From the Chinese point of view, they are
- The SED or an equivalent should be adopted by the new
President-to be led by the Vice President, not the Secretary
of the Treasury.
Economic dialogue with China may be even more complicated than
the next President anticipates. The importance and
multifaceted nature of the relationship call for an overarching
institutional mechanism like the SED. But some present
American objectives fly in the face of a state-dominated
development model that has yielded rapid growth and is thus deemed
very successful by the Chinese government. The recommendations made
in this paper take into account Chinese reaction and are
WTO-compliant. The lead negotiating authority in the SED can thus
be assertive in terms of legal or other actions in pursuing these
Though only modest progress can reasonably be expected until the
flaws of China's model become more apparent, true market-oriented
reform must remain the ultimate goal. The next American
Administration should, therefore, continue to state the case for
deeper liberalization of China's economy. This will emphasize
that long-term U.S. objectives have not changed and prepare
the ground for the time when China is again open to
Elements of the new Administration will surely offer alternate
views to the one argued here. An obvious alternative is to
pursue much more fundamental change on the Chinese side. With Hu
and Wen committed to a path that has brought at least 10
percent annual GDP growth since they assumed power, some will
maintain that sharp protectionist threats are required to move them
toward fundamental change. The problem with such protectionist
threats is not that they are not credible, but that they are not
effective, and in fact, counterproductive.
Protectionism will harm the U.S.-even if it harms China more. It
should not be credible to threaten to cut off one U.S. finger while
cutting off two of China's fingers. American leadership is
demonstrated by the confidence and ability to thrive in
competitive environments, at home, in global markets, and in
the People's Republic of China itself. Protectionism is a retreat
from that leadership.
Derek Scissors, Ph.D., is
Research Fellow in Asia Economic Policy in the Asian Studies Center
at The Heritage Foundation.
 World Bank, "World Development Indicators Database: Gross Domestic Product 2007," September 10, 2008, at /static/reportimages/82E0DCA18BE7FE81EB73AA39C79C5330.pdf (October 9, 2008); U.S. Census Bureau, "U.S. International Trade Statistics," at http://censtats.census.gov/sitc/sitc.shtml (September 11, 2008); and U.S. Department of the Treasury and Federal Reserve Board, "Major Foreign Holders of Treasury Securities," August 15, 2008, at http://www.ustreas.gov/tic/mfh.txt (September 11, 2008).
 "China Orders Utility Price Freeze," BBC News, May 10, 2004, at http://news.bbc.co.uk/1/hi/business/3699477.stm (October 9, 2008); Qingyue Meng, Gang Cheng, Lynn Silver, Xiaojie Sun, Clas Rehnberg, and Göran Tomson, "The Impact of China's Retail Drug Price Control Policy on Hospital Expenditures: A Case Study in Two Shandong Hospitals," Health Policy and Planning, Vol. 20, No. 3 (2005), pp. 185-196, at http://heapol.oxfordjournals.org/cgi/content/abstract/20/3/185?etoc (October 9, 2008); "Urban Compulsory Education Fees to Be Exempted," China Daily, November 10, 2007, at http://www.chinadaily.com.cn/china/2007-11/10/content_6245300.htm (October 9, 2008); Xinhua, "Railway Ticket Prices to be Increased During Spring Festival," China Daily, January 10, 2006, at http://www.chinadaily.com.cn/english/doc/2006-01/10/content_511054.htm (October 9, 2008); and "China Hikes Oil and Gas Prices by 18 Per Cent," Associated Press, June 20, 2008, at http://www.ctv.ca/servlet/ArticleNews/story/CTVNews/20080620/china_fuel_080620/20080620?hub=World (October 9, 2008).
 Rujun Shen and Jim Bai, "Update 2-China Tightens Coal Price Controls, Shortages Stay," Reuters, July 24, 2008, at http://www.Reuters.com/article/governmentFilingsNews/idUSPEK1598020080724 (October 9, 2008), and Dominic Meagher, "Understanding China's Oil Prices," East Asia Forum, at http://eastasiaforum.org/2008/06/25/understanding-chinas-oil-prices/ (October 9, 2008).
 "Over 5.5 Mln Private Enterprises Now Operating in China," People's Daily Online, November 19, 2007, at http://english.people.com.cn/90001/90776/6304800.html (October 9, 2008), and "Heavy Taxes, Hamper Chinese Private Business," China Daily, December 18, 2007, at http://chinadaily.com.cn/china/2007-12/18/content_6330249.htm (October 9, 2008).
 "CBRC: Total Banking Assets Reached RMB 57.5 Trillion," China Banking Regulatory Commission (CBRC), at http://www.cbrc.gov.cn/english/home/jsp/docView.jsp?docID=20080801DD09D887C99F6380FFE9ED3D9A37EF00 (October 9, 2008); Simon Rabinovitch, "Update 1-China Fixes 2008 New Loan Quotas for Big Banks-Source," Reuters, December 26, 2007, at http://www.Reuters.com/article/rbssFinancialServicesAndRealEstateNews/idUSPEK20725020071226 (October 9, 2008); and Jane Cai, "Banks Urged to Meet Loan Quotas for Small Firms," South China Morning Post, August 29, 2008.
 Jamil Anderlini, "China to Speed State Groups' Shakeup," The Financial Times, August 20, 2008.
 "China Slaps Windfall Tax on Oil, Gives No Size," Reuters, March 27, 2006 at http://asia.news.yahoo.com/060327/3/2i1df.html (October 10, 2008), and Zhu Qiwen, "Time to Take a Fresh Look at Oil Subsidies," China Daily, March 21, 2008, at http://www.chinadaily.com.cn/opinion/2008-03/21/content_6554797.htm (October 10, 2008).
 Zia K. Cromer, "China's WAPI Policy: Security Measure or Trade Protectionism?" Duke Law & Technology Review, No. 18 (2005), at http://www.law.duke.edu/journals/dltr/articles/2005dltr0018.html (October 10, 2008).
 "China Focus: Unprecedented Capital Inflows Test Chinese Regulators," People's Daily Online, July 1, 2008, at http://english.people.com.cn/90001/90776/6440136.html (October 10, 2008). Also, more FDI is coming from off-shore tax havens such as Samoa. In the first half of 2008, Hong Kong accounted for most spending growth and 45 percent of total FDI in China. The British Virgin Islands accounted for another 18 percent. Japan, Korea, and the U.S. combined constituted less than 11 percent. See National Bureau of Statistics, China Monthly Statistics, Beijing, Vol. 7, 2008. Explosive growth in outward investment by Chinese firms has led to the establishment of more overseas subsidiaries, beginning in Hong Kong. Money returned to the mainland from subsidiaries is counted toward FDI, though it has few of the qualities that make FDI desirable.
 Tom Holland, "Coke-Huiyuan Deal Poses a Thorny Problem for Beijing Friday," South China Morning Post, September 5, 2008.
 The most feared provision of the Labor Law requires that a permanent contract be offered after two fixed-term contracts.The terms under which employees with permanent contracts can be fired make doing so prohibitively costly. Another provision requires management to consult with the ACFTU before adjusting hours or wages. "Labour Law of the People's Republic of China," Standing Committee of the Eighth National People's Congress, July 5, 1994, at http://www.usmra.com/ china/Labour%20Law.htm (October 10, 2008). The ACFTU has uniformly ignored abusive behavior by state firms while periodically assailing foreign firms on comparatively minor grounds. "ACFTU: GE Seriously Violated China's Labor Law," China CSR, April 18, 2008, at http://www.chinacsr.com/en/2008/04/18/2269-acftu-ge-seriously-violated-chinas-labor-law/(October 10, 2008). For example, an unauthorized labor action against China Eastern Airlines revealed contract restrictions, ignored by the ACFTU, far harsher than practices attacked by the ACFTU at McDonald's. Edmund Klamann, "China Eastern Grounds Pilots After Strike Action," Reuters, April 7, 2008, at http://www.Reuters.com/article/rbssIndustryMaterialsUtilitiesNews/idUSSHA12724720080407 (October 10, 2008), and "ACFTU: Fast Food Restaurants Must Pay Workers in Line with Law," China CSR, April 5, 2007, at http://www.chinacsr.com/en/2007/04/05/1202-acftu-fast-food-restaurants-must-pay-workers-in-line-with-law (October 10, 2008). Unsurprisingly, the first clash over the Labor Law involved a multinational corporation. Kraft was accused of inadequate consultation before moving its headquarters. There is no standard for adequate consultation and the case was brought against Kraft even though it involved job relocation, not job loss. "Kraft China Accused of Violating Labor Law for Headquarters Moving Plan," March 12, 2008, China Daily, at http://www.chinadaily.com.cn/bizchina/2008-03/12/content_6529988.htm (October 10, 2008).
 Jeff Pao, Ng Tze-wei, and Bien Perez, "Support Builds for Probe into Microsoft," South China Morning Post, August 26, 2008.
 "The Quantity, the Application Conditions and the Principle of the Distribution of the Import Tariff Quotas of Grain and Cotton of 2005," National Development and Reform Commission of the People's Republic of China, No. 58, September 30, 2004, at http://www.fdi.gov.cn/pub/FDI_EN/Laws/ImportExport/ImportAdministration/P020060620382395006823.pdf (October 10, 2008), and David Winning, "China Non-State Cos 2009 Oil Product Import Quota 11.25 Million Tons," Dow Jones Newswires, August 26, 2008, at http://resources.alibaba.com/topic/342626/China_Non_State_Cos_2009_Oil_Product_Import_Quota_11_25_Million_Tons.htm (October 14, 2008).
 For example, Tom Miller, "Regulators Tighten Curbs to Block Hot Money," South China Morning Post, September 5, 2008.
 "Chinese Urban Workers' Per Capita Salary Up 18 Percent in H1," Xinhua, July 28, 2008, at http://news.Xinhuanet.com/ english/2008-07/28/content_8786414.htm (October 10, 2008).
 "Financial Performance Remained Stable in July," The People's Bank of China, August 13, 2008, athttp://www.pbc.gov.cn/ english//detail.asp?col=6400&ID=1131 (October 10, 2008), and "Financial Market Performance in January 2008," The People's Bank of China, February 26, 2008, at http://www.pbc.gov.cn/english//detail.asp?col=6400&ID=1029 (October 10, 2008).
 Urban investment is dominated by locally-controlled state entities and is three times larger than central budgetary expenditure. "China's Fiscal Surplus Hit 1.19 Trillion First Half of 2008," CriEnglish.com, August 8, 2008, at http://english.cri.cn/4026/2008/08/08/1241s391218.htm October 10, 2008).
 National Bureau of Statistics, China Monthly Statistics, Beijing, Vol. 6, 2002 to Vol. 7, 2008.
 "China to Reward Coal Companies that Increase Output," Dow Jones News, August 29, 2008.