Brookings: Topics - U.S.-China Strategic and Economic Dialogue

U.S.-China Study Group on G-20 Reform

Thu, 07 Mar 2013 14:34:00 -0500

The China Institutes of Contemporary International Relations, the Center for American Progress, and the Stanley Foundation formed a study group in late 2011 to evaluate the role of the G-20 in the U.S.-China bilateral relationship and the influence of the relationship on the G-20 and to propose recommendations that could improve the efficacy of this important body. The Chinese and American experts listed below held two conferences over the course of 2012, in Santa Monica, in February and in Beijing in October. At the end of these meetings, participants in the group agreed to 20 recommendations.

Read the U.S.-China Study Group's recommendations » (PDF)

Participants in the G-20 Study Group

Tim Adams, Managing Director, The Lindsey Group and former Sherpa and Undersecretary of the Treasury under President George W. Bush

Sabina Dewan, Director of Globalization and International Development, Center for American Progress

DU Yanjun, Director of the Department of International Exchanges, China Institutes of Contemporary International Relations (CICIR)

Elizabeth Economy, C.V. Starr Senior Fellow and Director for Asia Studies, Council on Foreign Relations

Matthew Goodman, Simon Chair in Political Economy, Center for Strategic and International Studies and former Director for International Economics in the Obama White House

Nina Hachigian, Senior Fellow, Center for American Progress

Adam Hersh, Economist, Center for American Progress

HUANG Ying, Associate Professor, the CICIR Institute of World Economic Studies

Bruce Jones, Senior Fellow and Director of the Managing Global Order (MGO) project at the Brookings Institution and Director of the Center on International Cooperation at New York University

LI Zheng, Assistant Professor, the CICIR Institute of American Studies

LIN Hongyu, Director of the Department of International Politics at the China University of International Relations

LIU Bo, Deputy Director of the Department of International Exchanges, CICIR

Stewart Patrick, Senior Fellow and Director, International Institutions and Global Governance Program, Council on Foreign Relations

Keith Porter, Director of Policy and Outreach, the Stanley Foundation

QIAN Liwei, Associate Professor, the CICIR Institute of American Studies

David Shorr, Program Officer, the Stanley Foundation

Randy Schriver, Armitage International

WANG Wenfeng, Deputy Director of the CICIR Institute of American Studies

YUAN Peng, Assistant President, CICIR and Director of the CICIR Institute of American Studies

ZHAI Kun, Director of the CICIR Institute of World Political Studies

ZHANG Wenzong, Assistant Professor, the CICIR Institute of American Studies

ZHU Feng, Deputy Director, Center for International & Strategic Studies, Peking University

ZHU Liqun, Vice President, China Foreign Affairs University

Publication: Center for American Progress, China Institutes of Contemporary International Relations and The Stanley Foundation

Image Source: © Kevin Lamarque / Reuters

U.S.-China Strategic Distrust a Major Problem

Kenneth G. Lieberthal — Mon, 30 Jul 2012 00:00:00 -0400

Editor's Note: On July 30, 2012, Yoichi Kato of The Asahi Shimbun interviewed Kenneth Lieberthal, director of the John L. Thornton China Center and senior fellow in Foreign Policy and Global Economy and Development at Brookings, about U.S.-China relations.

Yoichi Kato: What do you mean by “strategic distrust”?

Kenneth Lieberthal: The United States and China have, on balance, a relatively successful relationship. And we have learned how to deal with each other on major issues so that we are able to prevent disagreement in any one area from upsetting the entire relationship.

Having said that, in more than 30 years of U.S.-China diplomatic relations, we have not succeeded in persuading each other of our long-term good intentions in the relationship, so that each side distrusts what the other side will do over a 10 or 15-year period. That is what we term “strategic distrust.” Strategic, not meaning strictly military; meaning long-term and comprehensive.

Kato: What kind of negative impact could it have on the bilateral relations?

Lieberthal: The problem with “strategic distrust” is that it makes it difficult to take the initiatives that could actually build greater trust over time. So that, for example, on the military side we not only have a broad military policy that seeks engagement with China, but we also hedge. And there is a tendency in life for hedges eventually to become the mainstream policy. So this is, potentially, a very costly situation.

Kato: Your report warns that the problem is becoming more serious. What makes you think so?

Lieberthal: Since 2008 (when the Lehman shock and the global financial and economic crisis occurred), China’s footprint in the world has grown dramatically, in comparative terms, both because China is doing more and because the industrialized world has been faltering.

This, in 2010, created a perception, in the U.S. at least, that China was beginning to act in assertive terms, with the U.S. being a little unsure what the future held in that regard. I think we have seen since then great debate in China as to what China’s role ought to be, what its progress will be, and so forth.

But this question of our relative positions and responsibilities, bilaterally, regionally and globally has been raised in a way that was not nearly as pressing before 2008. And I think we do not have a comfortable sense of each other’s final answers to those questions, and that has increased this uncertainty and distrust.

Read the full interview »

Authors

Kenneth G. Lieberthal

Publication: The Asahi Shimbun

Image Source: Jason Reed / Reuters

Exploring the Possibilities for Collaboration Between the U.S. and Chinese Navies in the Western Hemisphere

Audry Oxley — Tue, 10 Jul 2012 11:00:00 -0400

The end of World War II marked the beginning of a global system of commerce installed and protected by United States maritime forces. This model of free trade laid the foundation for the People’s Republic of China’s inexorable rise in global affairs. The U.S. supported China’s industrialization by granting it near limitless access to American capital and consumer and financial markets, while it benefited equally from a vast and ever growing supply of consumer goods that have kept the cost of living in America nearly flat for a decade.

Now, however, both nations are expanding their economic interests and military commitments into each other’s regional neighborhoods. To complicate matters, this is happening at a time when both nations are finding themselves stymied by political and territorial challenges within their own hemispheres.

In this paper, U.S. Navy Lieutenant Commander Audry Oxley argues that managing future international issues between the countries will require a commitment to cooperation and a sturdy diplomatic platform.

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Authors

Audry Oxley

Image Source: Jason Lee / Reuters

Continue Progress on a Key Trade Relationship

Joshua Meltzer — Fri, 11 May 2012 00:00:00 -0400

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Editor's Note: For Campaign 2012, Kenneth Lieberthal and Jonathan Pollack wrote a policy brief proposing ideas for the next president on America’s relationship with China. The following paper is a response to Lieberthal and Pollack’s piece by Joshua Meltzer. Richard Bush also prepared a response arguing that the U.S. and China must reduce their mutual mistrust in order to cooperate on global challenges.

The size and strength of the American economy has underpinned U.S. leadership in the world, and the long-term prospects for U.S. economic growth are essential for maintaining this role. The strength of the American economy also matters for U.S.-China economic relations. As Kenneth Lieberthal and Jonathan Pollack conclude, the “single biggest factor determining the shape of the U.S.-China relationship over the coming four years will be the extent of America’s success in getting its domestic house in order.” While many of the challenges to the American economy are domestic in nature, international trade and investment matter. In 2008 more than 15 percent of U.S. gross domestic product came from international trade. In addition, in 2011 the United States earned more than $450 billion in income from a stock of over $4 trillion in direct overseas investment.

Also in 2011, total U.S.-China trade was $500 billion, and the U.S. trade deficit with China was $295 billion, making it the largest bilateral trade deficit the United States has ever had. How it manages its economic relationship with China will have important implications for the U.S. economy and job creation. Endeavors in this regard will also help ensure that China plays a leadership role in supporting the current global economic order.

One way President Barack Obama has sought to reduce barriers to U.S. trade and investment in China, such as weak protection of intellectual property and local technology procurement laws, has been through regular meetings of senior officials from both sides with the U.S.-China Strategic and Economic Dialogue (S&ED) and the U.S.-China Joint Committee on Commerce and Trade (JCCT). These meetings have provided opportunities to develop mutual trust, a critical ingredient for deepening and strengthening the bilateral relationship. As Lieberthal and Pollack observe, a deficit of trust regarding strategic, long-term intentions on both sides is at the heart of difficulties with the broader U.S.-China relationship. The next president should continue to invest time and energy in these meetings. Building trust between top U.S. and Chinese officials will be especially important in 2013 when a new Chinese leadership and potentially new American president take office. The next American president needs to be prepared to build stronger economic relations with China and in doing so deliver results for the U.S. economy.

The next American president must also place a premium on resolving trade issues with China at the World Trade Organization (WTO), where the United States has initiated a range of disputes against China’s trade practices. The WTO is another forum where regular interaction among officials helps develop greater understanding of the foundations of each country’s trade policies. Working within the WTO to address trade issues with China will reinforce the value of multilateral rules-based institutions and demonstrate to China the benefits of playing by the rules of the game. This is particularly important given the WTO’s current lack of direction on the Doha Round, and it will reinforce U.S. efforts to show China that the current global economic order—which includes the WTO—is worth supporting.

At the same time, the next U.S. president should invigorate the WTO as the key forum for trade liberalization. In addition, he should continue to support the Trans-Pacific Partnership (TPP), a regional free trade agreement that the United States sees as a vehicle for developing new rules for trade and investment in the Asia-Pacific region. Moreover, as countries seek to join the TPP negotiations, China’s nonparticipation in the process is something the next president will need to carefully manage. He should make clear that China is welcome to join the TPP when it can demonstrate its ability to live up to what will supposedly be high TPP standards. Steps must also be taken to actively engage China on the type of trade and investment policies it would need to adopt in order to join the TPP.

The international economic implications of the growing role of the state in the Chinese economy require attention as well. While China has benefited enormously from a system of open nondiscriminatory trade, the growing influence of the Chinese state in the Chinese economy presents many difficult challenges for U.S.-China economic relations and for the global economic system more broadly. Increasing state control in the Chinese economy has bred its own forms of protectionism as China’s state-owned enterprises—supported by immense subsidies in the form of cheap credit, low energy prices, and access to land—are typically less productive and competitive than their foreign rivals. This has led Chinese state-owned firms to advocate for protectionist trade and investment policies. These subsidies not only tilt the playing field in favor of state-owned enterprises but they also act as barriers to U.S. exports and investment.

Over the past several years, the United States has sought to give China a larger stake and leadership role in the global economic order by supporting changes to the voting structure of the International Monetary Fund and making China central to the WTO Doha Round negotiations. However, efforts to maintain the viability of state-owned enterprises will hinder China’s ability to provide the type of global economic leadership the United States envisions. To play such a role, China would have to further liberalize trade and investment and level the playing field for trade and investment both at home and overseas. China’s capital account would also have to be liberalized, which would mean moving to a floating exchange rate for the renminbi.

To address these issues, the next U.S. administration must build on existing bilateral economic meetings and develop a focused discussion with China on the growth of the state in its economy. In view of their global impacts, these issues should be taken up bilaterally, as well as in multilateral settings such as the WTO, the International Monetary Fund, and the G-20.

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Continue Progress on a Key Trade Relationship

Authors

Joshua Meltzer

Image Source: © POOL New / Reuters

Continuing Complex Discussions on Fate of Chinese Dissident

Jeffrey A. Bader — Thu, 03 May 2012 00:00:00 -0400

Since the announcement on May 2 that Chinese dissident Chen Guangcheng was leaving the U.S. Embassy in Beijing and would remain in China in return for Chinese assurances about his safety and future, the deal negotiated by U.S. and Chinese officials has come unstuck. Chen spoke to his legal advisor Teng Biao while at the hospital shortly after his departure from the embassy and Teng persuaded him that Chinese promises could not be trusted. Chen then told the international media that he now wished to seek asylum in the U.S. instead. Since he had been insistent while at the embassy that he did not seek to go abroad, this ran contrary to what U.S. officials had been led to expect. As a result, Chen is now insisting that the U.S. Government achieve a result that it cannot independently produce, namely to transport a Chinese citizen under Chinese authority out of China. The U.S. Government is now seeking to ascertain what Chen really wants, and will try within the limits of the possible to accommodate his desires.

In the meantime, the Strategic and Economic Dialogue continues. The Chinese side clearly wishes to keep the Chen matter in perspective and emphasize the positive in the US-China relationship, as evidenced by the announcement that its Defense Minister will visit the United States shortly. It will be a considerable challenge for the U.S. and China to keep the relationship steady as the Chen matter oscillates from day to day. The U.S. objective remains clear – to protect Chen’s rights as much as it can while keeping focused on the major global and regional issues on which a common approach is critical. If the U.S. fails to protect Chen adequately, the relationship will come under withering fire at home. If on the other hand the U.S. makes the Chen case the central issue in U.S.-China relations, it will damage crucial global objectives. Amongst the tension and uncertainties of the moment, a balanced approach remains imperative.

Authors

Jeffrey A. Bader

Image Source: Reuters

Importance of the U.S.-China Strategic and Economic Dialogue

Kenneth G. Lieberthal — Wed, 02 May 2012 15:59:00 -0400

On the eve of the U.S.-China Economic and Strategic Dialogue, China’s human rights policies, including the case around Chinese dissident Chen Guangcheng, are not preempting other agenda items. Kenneth Lieberthal says the capacity to deal with this issue while also holding the Strategic and Economic Dialogue reflects the relative maturity of current U.S.-China relations.

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Human Rights Issues will not Trump U.S.-China Dialogue

Chen Guangcheng and the U.S.-China Strategic and Economic Dialogue

Jeffrey A. Bader — Wed, 02 May 2012 00:00:00 -0400

Editor's Note: Read an update by Jeffrey Bader on Chen Guangcheng, his decision to ask for asylum, and the U.S.-China Strategic and Economic Dialogue.

The resolution of the drama triggered by the presence of Chinese dissident Chen Guangcheng in the U.S. Embassy this past week on the eve of the U.S.-China Strategic and Economic Dialogue (S&ED) removes a dark cloud from the U.S.-China relationship at a crucial time. The negotiated deal leading to the decision by Chen to leave the U.S. Embassy in Beijing on May 2, where he had sought sanctuary six days earlier, ended a brief stalemate that could have had significant negative ramifications had it not been quickly resolved.

Chen, a self-taught legal activist who has been involved in issues such as countering forced abortions and highlighting tainted blood supplies that have caused HIV/AIDS, had been under imprisonment and house arrest for years. He somehow escaped his house arrest and made his way from Shandong province to the American Embassy where he was given refuge (the U.S. government wisely refused all comment on the case in order to facilitate a positive outcome, which would have been rendered very difficult by putting a spotlight on it). The case was especially difficult for the Chinese at this moment, coming just weeks after the fall from power of the powerful former Party Secretary of Chongqing and rising star, Bo Xilai, in the wake of his ex-police commissioner seeking temporary refuge in the US Consulate-General in Chengdu.

U.S. Assistant Secretary of State for East Asian and Pacific Affairs Kurt Campbell and Legal Counsel Harold Koh negotiated an agreement with the Chinese Foreign Ministry under which Chen chose voluntarily to leave the embassy with assurances by the Chinese to him and to the U.S. Government that he would be treated humanely, not be sent back to Shandong into house arrest, and be reunited with his family. Chen had not requested exile, so he saw this outcome as satisfactory. It was surprising how quickly the Chinese government agreed to this solution, under which the U.S. Embassy will periodically check on his status, perhaps indicating that they did not want continuing attention to this case as the S&ED took place.

While all this was going on, Secretaries Clinton and Geithner arrived in Beijing for what will be the fourth and almost certainly the last meeting of the Strategic and Economic Dialogue (S&ED) in which they participate. The S&ED was established in 2009 as a framework for talks by Cabinet-level officials from a slew of agencies on each side, chaired on the Chinese side by Vice Premier Wang Qishan and State Councilor Dai Bingguo, who respectively oversee the economic and foreign policy portfolios. The S&ED was not designed as a body to produce “deliverables” or solve problems, but rather more as a way of focusing on key issues, elevating attention to the U.S.-China relationship once each year, and breaking down bureaucratic stovepipes on both sides but especially on the Chinese side. It remains to be seen whether the mechanism will continue in precisely its current form under the successors to Clinton and Geithner, whether Democrat or Republican.

The U.S. delegation to the S&ED will try to focus on the large issues in the relationship on which Chinese behavior can significantly affect our interests – Iran, North Korea, the South China Sea, military and security bilateral tensions, market access, currency levels, investment flows, and factors that tilt the economic playing field. There will be a separate meeting of the Strategic Security Dialogue before the S&ED involving senior uniformed military and civilians from the defense and foreign policy establishments to discuss maritime security and cyber-issues. While the meeting will be brief, this innovation begun at last year’s meeting is an important first step toward a serious dialogue to address and contain the contentious bilateral security differences that could escalate and lead to conflict or hostility.

The S&ED comes 5 1/2 months after a trip by President Obama to Asia that was portrayed and perceived, wrongly, as a campaign to “contain” China and that has caused a certain amount of brooding on both sides about the state of the relationship. In the interim, China’s Vice President and heir apparent Xi Jinping made a generally successful visit to the U.S., and the U.S. and China have addressed the North Korean and Iranian nuclear programs in more effective cooperative fashion. The two sides hope to use the S&ED to build positive momentum in the relationship. The mere fact that the S&ED is proceeding at a moment of special difficulty occasioned by the Chen case testifies to the durability of the relationship in the face of daily travails.

Authors

Jeffrey A. Bader

Image Source: Jason Lee / Reuters

U.S., China Must Overcome Mutual Distrust

Kenneth G. Lieberthal — Tue, 10 Apr 2012 00:00:00 -0400

The United States and China have the most important bilateral relationship in the world. Whether they can develop a constructive, cooperative relationship or whether they become each others' greatest nightmare has enormous consequences for each country and for the capacity of the international system to manage regional and global issues.

Both leaderships recognize what is at stake, which explains why, despite many disagreements, Washington and Beijing constantly stress the importance of building ties. The two governments conduct more than 60 formal dialogues a year and engage each other daily, to a far greater extent than most people realize.

Despite these efforts, each country has an underlying and growing distrust of the other's long-term intentions. Such distrust is corrosive, casting even well-intentioned actions and initiatives in a negative light.

When President Nixon opened the door to Beijing 40 years ago, nobody imagined that U.S.-China relations would develop to this point. But extensive governmental contacts between the nations, economic interdependence and huge flows of students and tourists back and forth have failed to stem the growth of underlying mutual distrust. That distrust could well create a self-fulfilling prophecy of eventual confrontation.

A key problem is that neither government is confident that it understands how the other sees the future of their relationship. Although each side senses distrust in the other, the real reasons for that attitude are unclear. So, how do they separate propaganda efforts designed to manipulate from sincere concerns?

Because this is such a tough and consequential problem, I teamed up with one of China's leading America specialists to write a report that lays out the underlying worries that each side has about the other and, especially, why they have these deep concerns. Our report was published simultaneously last week in English and Chinese.

My colleague wrote, in unvarnished fashion, about the analysis that leads many policymakers in China to believe the ultimate goal of the United States is to constrain or disrupt China's rise and to undermine its political system. I wrote about U.S. hopes for a normal major power relationship with China over the long run and the reasons why many American policymakers are increasingly concerned that this may prove impossible.

The reasons are complicated. In part, they include the inevitable tensions that arise when a global balance of power is changing. My colleague and I expect that America will retain its leading role for many years to come, but the gap between U.S. and Chinese power and position is narrowing. Because of that, many in China fear the United States might resort to anti-Chinese measures to maintain its lead. American officials worry not so much that China will rise, but that Beijing will believe it can only do so at direct cost to the United States.

Our enormously different political systems exacerbate this distrust. Neither side understands very well the political and institutional constraints in the other's system, and both are inclined to assume the other is more strategic, centralized and internally disciplined than it is. Neither is certain that it knows when the other is being honest about its domestic political constraints, and both tend to take random events as reflections of strategic intent.

Beijing views America's pro-democracy foreign policy as aimed, in part, at changing China's system, while Washington inherently distrusts the motives and actions of authoritarian governments. And unsurprisingly, both sides have partially institutionalized distrust in their militaries, intelligence agencies, and offices focused on cybersecurity.

Distrust about long-term intentions is thus grounded in complicated narratives in both countries. Neither side wants an adversarial relationship, but both worry that it may become unavoidable. And extensive efforts to build mutual trust to date are not working.

New measures are necessary. Both governments must discuss, in depth, topics they have been avoiding. What overall military postures in Asia will both permit China to meet its vital security needs and enable America to defend its allies and interests? What kinds of mutual restraint can help bring about this outcome?

How does each side view potential developments on the Korean Peninsula over the coming decade, and how would both plan to react to each scenario?

America conducts surveillance activities just outside China's territorial waters that Beijing views as hostile and degrading. Could China provide some type of increased military transparency that could change this? Could the military component of the Taiwan issue be reduced?

Understanding views of the long term, clarifying thinking on key military issues and devising concrete efforts to build mutual confidence are the initiatives that could alter the perceptions in Washington and Beijing that enhance distrust. The future can be shaped by intelligent actions, but those must be based on clear recognition of the reasons why each side fears the future intentions of the other.

Authors

Kenneth G. Lieberthal

Publication: CNN

Image Source: LARRY DOWNING

U.S.-China Strategic and Economic Dialogue Is Vitally Important

Kenneth G. Lieberthal — Fri, 06 May 2011 13:53:00 -0400

The third round of the Strategic and Economic Dialogue (S&ED) between U.S. and Chinese officials will take place in Washington beginning May 9. Cabinet secretaries Hillary Clinton and Tim Geithner will host the two days of the S&ED, which provides a forum for talks about strategic and longstanding issues important for U.S.-China relations. Kenneth Lieberthal, who directs the John L. Thornton China Center at Brookings, notes that these meetings are critical for the enhancement of mutual trust, cooperation and understanding between the global powers.

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U.S.-China Dialogue Vitally Important

U.S.-China Senior Dialogue: Maintaining the Balance

Jeffrey A. Bader — Fri, 06 May 2011 16:36:00 -0400

The third U.S.-China Strategic and Economic Dialogue (S&ED) will take place on May 9-10 in Washington, D.C. Chaired once again by Secretaries Clinton and Geithner on the U.S. side and Vice Premier Wang Qishan and State Councilor Dai Bingguo on the Chinese side, the dialogue will bring together about a dozen Cabinet and Ministerial rank figures on both sides along with a host of Vice Ministers and other senior officials from a nearly a score of departments.

The S&ED was not conceived as a mechanism to deal with bilateral crises or to produce specific “deliverables,” but to develop a richer, more intensive dialogue between senior officials on the two sides than would be possible in the usual quick in-and-out visits, and to break down bureaucratic stovepipes among agencies, particularly on the Chinese side, not accustomed to coordinating effectively with each other. It provides a way to sustain and propel cooperation on issues like energy and environment, development assistance, and food security that might not get sufficient attention in regular bilateral meetings dominated by urgent and pressing issues. It also serves as a reminder to top officials on both sides of the diversity and complexity of the relationship, to help them put problems in the broad context of the relationship rather than allowing individual problems to spiral out of control.

One of the notable features of this year’s S&ED will be the participation of a senior PLA officer, General Ma Xiaotian, for the first time. The Obama administration has sought to develop a dialogue with the Chinese on the most difficult global security issues that have the potential to lead to conflict. U.S.-China dialogue in such areas has lagged beyond even the levels of U.S. discussions with the former Soviet Union, in part because of Chinese difficulty in engaging civilian and military officials in the same discussion and because of Chinese reluctance to discuss such issues from a position of relative weakness. It would be a significant first step toward long term tension reduction and conflict management if the two sides can engage in serious discussions on at least some of these issues.

The S&ED comes at a time when U.S.-China relations are in fundamentally sound condition. President Hu Jintao’s visit to the United States was generally assessed as setting a realistic tone and achieving successes in a relationship that will always be marked by frictions. President Obama, who will be involved in the S&ED, has put a high priority on U.S.-China relations, and the two sides have cooperated, within limits, on major security issues, including Iran, Korea, Sudan, Libya, and nuclear security. From the U.S. perspective, it will certainly not hurt that the meeting comes only a week after the successful raid that eliminated Osama bin Laden, which sends a message of U.S. strength and credibility in a relationship where those qualities are always the subject of Chinese scrutiny. The United States and China have developed reasonable expectations about both the possibilities and limits of cooperation, which will reduce the chances of future miscalculation. All of these subjects, plus broader developments in the Middle East, will be on the agenda of the S&ED.

On the economic side, the need for the RMB to appreciate will be on the agenda, but will not be the kind of preoccupying issue that it was for much of the Obama administration’s first two years. This is because China has allowed a 5 percent rise in the value of the RMB over the last year, and with inflation its competitive advantage vis-à-vis the dollar has declined about 10 percent. Other issues, such as ensuring that Hu Jintao’s commitments on indigenous innovation discriminatory policies, IPR protection, and market access, will draw more attention. Also likely to be discussed will be the investment climate not only for U.S. companies in China but for Chinese companies in the United States.

Protection of human rights will feature as well in Secretary Clinton’s dialogue with Dai Bingguo, largely because of the repressive domestic atmosphere imposed by Chinese authorities in the wake of the “Arab Spring” in order to avoid contagion. The two sides recently held a human rights dialogue at the level of Assistant Secretaries, in which the U.S. side took a thoughtful approach of stressing issues of concern to Chinese people and groups, mitigating the risks of appearing to be imposing U.S. customs and norms on a suspicious China. That said, history encourages modest expectations about the fruits of U.S.-China dialogue on human rights. The Chinese see this as an issue to be dealt with domestically and managed internationally, not as one where they need to accommodate foreign complaints.

Authors

Jeffrey A. Bader

The U.S.-China Strategic and Economic Dialogue: A Preview of Key Economic Issues

Eswar Prasad — Fri, 06 May 2011 13:55:00 -0400

Expectations for the U.S.-China Strategic and Economic Dialogue meeting are muted—perhaps a good sign as it shows a maturing in the U.S.-China relationship. The focus has shifted to making methodical if slow progress rather than on resolving major conflicts or arriving at dramatic breakthroughs. There are of course differences in the objectives of the two sides and different perceptions of what constitutes progress. This enhances the value of the U.S.-China dialogue even if there are few high-profile successes to trumpet.

The rhetoric on both sides has ratcheted down as progress has been made on some of the most visible points of tension. The currency issue continues to fester but recent developments have transformed this into a problem for the rest of the world rather than just for the U.S.-China relationship. However, there are storm clouds gathering on the horizon as more fundamental and contentious issues, with high stakes on both sides, come to the fore.

In the coming months, discussions on economic policy will be increasingly overshadowed by the political calendars in the two countries, which herald a gradual hardening of positions and less room for maneuver on both sides. This makes it unlikely we will see any major policy shifts in the bilateral relationship, unless dictated largely by domestic political and economic circumstances.

The two countries are increasingly dealing with each other on an even footing and recognize that collaboration is in their mutual long-term interests. However, there lies a rocky road ahead, as domestic economic and political priorities and constraints drive the short-term dynamics of this relationship.

Do not count on any surprises or major breakthroughs next week.

The U.S. Spells Out Its Position

In a speech earlier this week, U.S. Treasury Secretary Geithner reiterated a clear quid pro quo that defines the overall parameters of the bilateral economic relationship [1]. The speech makes the U.S. position clear that in order to attain China’s objectives in the bilateral relationship, China must adequately satisfy U.S. interests. China’s objectives are seen as including access to high technology products, investment opportunities in the U.S. and market economy status.

For its part, U.S. interests lie in greater market access for its companies, including in government procurement; stronger protection of intellectual property rights; and other reforms that would ensure a level playing field within China for domestic and foreign producers. Secretary Geithner’s speech acknowledges the commitments made on some of these issues during President Hu’s visit to Washington in January but, with good reason, reserves judgment on China’s implementation of these commitments.

Secretary Geithner also urges faster implementation of China’s own reform agenda—financial market reforms, a more flexible exchange rate regime, and growth rebalancing to stoke private consumption and make the economy less dependent on exports or investment. While there are differences in opinion about the desired pace of these reforms, there is agreement on both sides that such reforms would promote the sustainability and durability of China’s growth and also contribute to the global rebalancing effort.

The U.S. has also been quite supportive of China’s increasingly ascendant role in international financial institutions. At a recent G-20 conference, Secretary Geithner was explicit in his support for eventually including the renminbi in the basket for the IMF’s Special Drawing Rights (SDR), subject to certain conditions like currency convertibility being met.

Trade and Currency—A Bilateral Perspective

The ebbs and flows of the U.S.-China relationship have turned largely on trade flows although bilateral financial flows have become increasingly important [2]. Indeed, the bilateral trade deficit gets far more attention than it rightly deserves. This bilateral deficit shrank to $227 billion in 2009, compared to $266 billion in 2008. In 2010, it rebounded to an all-time high of $273 billion. The 12-month moving average and the rising import demand from a recovering U.S. economy portend a continued high bilateral deficit in 2011 (Figure 1).

This will no doubt direct further attention to China’s currency policy. Following its re-depegging from the dollar in June 2010, the renminbi has appreciated by about 5 percent in nominal terms against the dollar (Figure 2). On an inflation-adjusted basis, this implies that the renminbi is appreciating at a rate of about 8 percent a year in real terms relative to the dollar. Quibbles about the pace of appreciation aside, this means that the currency issue is no longer front and center in the bilateral dialogue.

China’s Currency Policy—A Broader Perspective

While China’s currency has been appreciating against the dollar, the dollar has of course been in retreat against other major currencies. Since June 2010, the dollar has depreciated in trade-weighted inflation-adjusted terms by about 8 percent (last two columns of Table 1). Consequently, despite its nominal appreciation against the dollar and the high inflation rate in China, the renminbi’s real effective exchange rate has actually depreciated modestly over the past year (Table 1).

This creates a difficult situation for the rest of the world as the two largest economies now have depreciating currencies. But it is no longer a U.S. problem and in principle it should foster an alliance among the U.S. and China’s major trading partners, especially other emerging markets, to push China to allow its currency to appreciate more rapidly. This is not a slam-dunk, however, as the rest of the world has still not quite forgiven the U.S. for QE2 and the damage it ostensibly wrought on their economies. So the battle between these two superpowers for the hearts of other countries rages on.

The broader battle has been muddied by the fact that China’s trade and current account surpluses relative to GDP have continued to shrunk since their peaks in 2007 (Figure 3). There is a sharp divergence of views among analysts about the direction in which these surpluses are headed. One view is that China has made durable progress in rebalancing its economy and reducing its dependence on exports. An alternative view is that China’s shrinking trade surplus is largely a cyclical phenomenon. China has grown strongly, sucking in huge quantities of imports, while its major export markets in the euro zone and the U.S. are just getting back on their feet after the global financial crisis.

This spills over into a raging debate about whether China has actually made significant progress on rebalancing its economy and contributing less to global imbalances. This is summarized by the stark difference between two key institutions in their forecasts for China’s current account to GDP ratio—the IMF pegs it at over 6 percent in 2012 while the World Bank puts it a shade under 4 percent (Table 2). My view is that both China’s trade and current account surpluses will rebound sharply as cyclical factors unwind, especially if China manages to clamp down on credit growth while the U.S. and Europe solidify their recoveries (all of which remain slightly dubious propositions at this stage).

In any event, currency dynamics show that China continues to intervene massively in foreign exchange markets to counter pressures for renminbi appreciation. China accumulated $448 billion of foreign exchange reserves in 2010, matching the pace in 2009 (Figure 4). The merchandise trade surplus of $185 billion (goods trade) accounts for less than half of this reserve accumulation in 2010 (the overall trade surplus on goods and services was lower at about $165 billion). It is also unlikely that valuation effects can account for the rapid pace of accumulation in 2010 [3].

China’s torrid pace of reserve accumulation continued in the first quarter of 2011, when it accumulated another $196 billion of foreign exchange reserves (Figure 4, lower panel). Valuation effects could account for about $50-60 billion of this increase [4]. On the other hand, China recorded a marginal deficit on its trade account in this quarter.

Even assuming significant returns on its existing stock of reserves, the implication is that capital continues to seep into China through a variety of channels despite all the controls on inflows. Managing capital flows and their impact on domestic liquidity and inflation will be a major challenge for the Chinese government during 2011, especially if it continues to strongly resist currency appreciation.

All of this makes it perplexing that China has not used currency appreciation more aggressively as a tool in the fight against inflation. Indeed, inflation in China has continued to rise despite modest increases in interest rates and sharp increases in reserve requirements, both of which have helped moderate credit growth (Figure 5). It seems that a huge political bar has to be crossed before the Chinese leadership accepts the use of currency policy as a tool against inflation.

China’s Concerns

During the dialogue, China will not be on the defensive. Its delegation will bring two concerns to the table--the more immediate issue of the prospect for a U.S. debt default and the longer-term issue of U.S. policy toward Chinese investment.

The Chinese delegation will certainly have some tough questions for the U.S. Treasury about the possibility and implications of a technical default on government debt if gridlock on Capitol Hill doesn’t get resolved before the U.S. hits its legal debt ceiling. But the tough questions don’t translate into a credible threat or a strong bargaining position. China has few alternatives and simply cannot take a significant fraction of its Treasury holdings elsewhere. Indeed, for all its worries and aggressiveness on the issue, the stark reality is that China has little choice but to accumulate even more U.S. government debt if it continues to pile up reserves at the rate of $150-200 billion dollars each quarter.

The U.S. has effectively countered the aggressive approach that China has taken on its purchases of U.S. debt. The Obama administration has quite clearly shifted the narrative around from the perspective that China has the upper hand in this relationship due to its ownership of U.S. Treasuries. Indeed, the administration has made it quite clear that it encourages China to reduce its intervention in currency markets, which would result in less reserve accumulation and reduced purchases of U.S. government debt. Fears that Chinese expressions of concern about U.S. public finances are a cloaked threat to dump U.S. debt are hyperbole.

China now has a massive stash of cash that it wants to use to purchase high-quality hard assets, especially foreign firms with strong R&D and technology that will help Chinese industries move up the value-added chain. The U.S. is prime hunting ground for such assets but there are major political constraints to Chinese investments in the U.S. An investment treaty would break down many of these barriers and uncertainties, and is eagerly sought by the Chinese. But it remains a prize that the U.S. will extract a significant price for and it is unlikely that the U.S. will substantially lower the safeguards against foreign investment in key sectors of its economy.

The Political Context

With the unemployment rate now below 9 percent and job growth modestly positive, next week’s meetings will take place against a more benign economic backdrop in the U.S. Moreover, Republicans in Congress have made it clear that currency legislation against China is not a priority. This gives the administration a little more leeway (and perhaps a little less bargaining power) in its dealings with the Chinese.

The political calendars of the two countries will drive the debate on economic issues. The Chinese leadership transition that begins in early 2012 and the U.S. presidential elections in the fall of 2012 could lead to a hardening of positions on both sides and also to some degree of policy paralysis, especially on bilateral issues.

China is keen to ensure a smooth transition to its new leadership in early 2012, making it unlikely that there will be significant policy shifts or initiatives in the latter half of 2011. The reformist credentials of the presumed heirs to President Hu Jintao and Premier Wen Jiabao are unclear and untested. In any event, the jockeying for senior positions and the work the new leadership needs to do to consolidate its power all point to the low probability of any major policy shifts during the first half of 2012.

The waters will appear calm and friendly at next week’s discussions but there remain deep and difficult tensions hidden beneath the surface.

Footnotes:

[1] The text of Mr. Geithner’s remarks is available at (http://www.treasury.gov/press-center/press-releases/Pages/tg1160.aspx). These remarks essentially carry over from his speech in January 2011, ahead of President Hu’s visit to Washington, where this explicit quid pro quo was introduced (http://www.treasury.gov/press-center/press-releases/Pages/tg1019.aspx).

[2] For a more detailed analysis of different facets of the bilateral economic relationship, see “Rebalancing the China-U.S. Relationship” by Eswar Prasad and Grace Gu, Brookings Institution Report, January 2011.

[3] Indeed, the dollar appreciated slightly relative to the euro during the year. The dollar-euro rate was 1.43 on Dec. 31, 2009 and 1.34 on Dec. 31, 2010. Assuming that most of China's foreign exchange reserves are held in instruments denominated in dollars or euros, this means that the valuation effects in fact held down the pace of reserve accumulation in dollar terms.

[4] The euro appreciated relative to the dollar by about 6 percent during the first quarter. Assuming that about one-third of China's reserves are held in euro-denominated investments, the valuation effects in dollar terms could account for about $55 billion (2.84 trillion * 1/3 * 0.06). The Japanese yen, by contrast, depreciated slightly relative to the dollar during the quarter.

Authors

Eswar Prasad

Managing the China Challenge in Business

Kenneth G. Lieberthal — Fri, 06 May 2011 13:23:00 -0400

Because U.S.-China business plays such an important role in our overall relationship, the 2011 U.S.-China Strategic and Economic Dialogue (S&ED) is again highlighting major American concerns about access to the China market. The issues—China’s policies on government procurement, indigenous innovation, and intellectual property protection, among others—pose serious obstacles to American corporations seeking to compete in the rapidly growing Chinese market, and they rightly receive a lot of U.S. government and media attention.

But many of the limitations on U.S. corporate performance in China are more tractable than the above long term issues. These limitations result from insufficient understanding among multinational corporation (MNC) executives of the evolving Chinese opportunity and of how the Chinese political system operates and interacts with the country’s economic enterprises (that is, of China’s “political economy”). China’s system leaves a lot to be desired in terms of transparency, but there is actually a lot more understanding of business-relevant parts of its political economy than most executives realize. And those insights have major implications for MNC corporate strategy.

I have provided the pertinent details on the evolving business opportunities, on China’s political economy, and on the resulting significant implications for MNC corporate strategy in a new book, Managing the China Challenge: How to Achieve Corporate Success in the People’s Republic (Brookings Press, May 2011). As this book explains, the current Chinese political system produces rapid economic growth as a necessary outcome of the way the political system itself operates.

Core to this is “the deal”—the understanding that qualifies the top leaders at every level of the system from province through city through county through township for promotion if they can make the GDP of the territory they govern grow every year while avoiding popular unrest or major embarrassments (such as huge product safety scandals). In return for this performance, their superiors grant them sufficient flexibility to devise ways to produce GDP growth, high performance evaluations if they succeed, and considerable tolerance for corrupt personal enrichment. The local leaders also have the scope of authority—over bank lending, local regulations, and the court system—to enable their own enterprises to do well and major projects to get built.

The results are predictable. They include very rapid growth, competition among localities for resources and opportunities, an abundance of infrastructure projects (because they represent visible growth and provide large flows of funds from which to skim), significant local protectionism, very inconsistent (at best) implementation of environmental regulations, and substantial corruption. This system promotes leaders who are highly entrepreneurial and also know how to manage politics and security. It is core to the reality that the Chinese Communist Party functions in fact as the Chinese Bureaucratic Capitalist Party, which in turn has become a virtually unstoppable growth machine.

Beyond “the deal” (which is nowhere codified in written form), there are many rules and practices that allocate authority in the Chinese party and government. If you know the right questions to ask, you can map out the lines of authority that are pertinent to the business objectives you seek. The bottom line is that the Chinese political system generally operates according to consensus, and MNCs may, if they know what they are doing, become active players in forging the consensus they need to move forward. The book provides details on how to do this.

This is, of course, an environment with enormous risks in almost every dimension. But there are risk mitigation strategies that are important to understand and apply. Because the risks reflect the underlying political economy, understanding that piece of the puzzle is critical to anticipating risks and forging effective approaches to reducing them.

All of this has major implications for the fundamentals of MNC strategy, including product development, marketing, human resources, and internal financing, among other issues. The bottom line is that it is possible to compete more effectively in China if you penetrate the veil of China’s seemingly opaque political economy, understand its internal workings, and apply those insights to corporate strategy. The resulting requirements are far reaching and difficult—but they are also key to sustained success.

The Strategic and Economic Dialogue is important, as are the economic and trade issues on the U.S.-China official agenda. But American MNCs can take appropriate measures in this tough Chinese environment to substantially increase their ability to benefit from China’s growth as well as from its deep-seated problems. This core reality should be kept in mind as the national media focus on the big issues in the S&ED. To the extent American-based businesses succeed in the People’s Republic, the beneficial repercussions for U.S.-China relations will be significant.

Authors

Kenneth G. Lieberthal