Statement of

Robert B. Cassidy

Director

International Trade and Services

Collier Shannon Scott

Before the

U.S.-China Economic And Security Review Commission

China’s WTO Compliance and U.S. Monitoring Efforts

February 5, 2004

Members of Commission, good morning and thank you for inviting me to testify today on China’s compliance with its obligations under the World Trade Organization (WTO) and U.S. monitoring efforts.  I am particularly pleased to have the opportunity to evaluate the effectiveness of an agreement that I had such a large role in negotiating.  As I compare the present situation with the past, the dynamics of that assessment are still very much like the dynamics of the negotiations themselves – full of extremes.   There are those who see China’s accession as a panacea for economic woes and those who see China as the pariah of the trading system.  Your hearing today may demonstrate that China is both.

The issue of China’s compliance with its WTO obligations must be put into its proper perspective.  Although the United States led those efforts and Ambassador Barshefsky was, in my view, the driving force in that achievement, China’s obligations are global commitments.  And thus, there are global responsibilities that we share with other WTO members.  Far too often, the United States is called upon to shoulder the burden of leadership on global trade issues alone.  But in the case of China’s WTO compliance, success will only be achieved when the United States and other WTO members work together.   So the comments that I am making today apply equally to other WTO members, and as long as those nations depend on the United States to enforce China’s commitments, the global trading system will be worse off. 

Four years have transpired since we concluded the market access agreement between the United States and China, the turning point in China’s 15-year journey to join the WTO.  Although long and difficult negotiations continued until China joined the WTO in December of 2001, those market access commitments were the building blocks for China’s accession agreement.  I reference that agreement because it represented a carefully conceived and executed set of commitments that, even then, embodied a combination of checks and balances between rights and obligations, designed to ensure that both China and the United States would benefit from China’s accession.  The eventual accession agreement codified those checks and balances and extended them to other WTO members.   Why were those checks and balances needed?  Simply put, the integration of a non-market economy country the size of China into a trading system -- designed for and dependent on the efficient operation of markets -- was a challenge of monumental proportions that had never been experienced before and maybe since.  On the Chinese side, the task of revising its laws and regulations was astounding.  China revised over 2000 laws and regulations and continues still to bring existing laws and regulations into conformity with new obligations as they arise.  If observers were to grade China on its efforts to bring its laws and regulations into compliance, just on the basis of the sheer volume of changes, that grade would be significantly above passing. 

Benefits to China

China has certainly benefited from the agreement.  Its economy has been one of the fastest growing in the world.  Its gross domestic product is expected to exceed 11 trillion Yuan or 1.3 trillion U.S. dollars at today’s nominal exchange rate.  Its GDP is estimated to have grown by 8.5 percent last year, but private economists believe that growth has exceeded 9 percent in the most recent months.  Much of the growth has been fueled by increasing investment, which exceeded $50 billion last year – more direct investment than received by either Japan or, for the first time, the United States.

Benefits to the United States

Statistics do not clearly indicate whether the United States has benefited from the agreement.   Since China joined the WTO, U.S. exports to China have grown by over 36 percent, while imports have grown by slightly more than 25 percent.  Nevertheless, because the value of imports far exceeds the value of exports, our bilateral surplus continues to grow and may reach $125 billion this year -- almost equal to our global trade deficit last year.   The increased exports to China appear to indicate that the U.S. economy is benefiting from China’s reduced tariffs, non-tariff measures, and a more open economy.  However, a more careful look at the statistics will show that the greatest increases in exports were for crude materials.  Instead of benefiting from increased exports of manufactured goods to China, U.S. manufacturers are facing critical shortages of products such as copper, iron, and aluminum scrap -- all of which are flowing to China’s rapidly expanding economy.  The expectation that the United States would see accelerated exports of high technology goods has simply not materialized to the extent that policy makers and legislators hoped and expected.  This raises the question of whether the United States has been relegated to the role of a supplier of raw materials to China’s burgeoning economy.

Your hearing today is designed to examine China’s record in implementing its WTO obligations.  Judging from the list of speakers at today’s hearing, the commission should have a comprehensive assessment of China’s implementation record and the effectiveness of the U.S. monitoring mechanism.  So, rather than repeat what I believe will be detailed presentations of their assessments of China’s compliance with its WTO obligations, I would like to take a different track.  I would like to step back from the specific commitments in each sector and assess, first, where the shortcomings in exercising the checks and balances have affected China’s implementation of the agreement and, second, assess the shortcomings of the agreement itself.  I believe that these shortcomings have had and will continue to have a dramatic effect on the overall effectiveness of China’s accession agreement and China’s integration into the global trading system.

Implementation Deficiencies

USTR has published a detailed list of areas where China has failed to effectively implement its obligations.  Not surprisingly, the expectations of negotiators coincide with the actual results.  When we negotiated the market access agreement, we expected that China would fully implement those provisions that were specific and detailed and China has, in fact, fully implemented the tariff cuts and actual quota levels (although not the quota allocation system) as we expected.  Yet, China’s implementation record on the less specific commitments is, as expected, deficient.  Like all countries, those deficiencies relate directly to the importance – whether political or economic – of the various sectors that seek protection.  Thus the implementation of agricultural tariff rate quotas (TRQs), has failed despite our attempts to create a detailed quota allocation system.  Moreover, China has used non-tariff measures to keep other agricultural products out of the marketplace.  Soybean exports languished in 2002 cue to the uncertainty surrounding restrictions on biotechnology products, until shortages in the domestic market created increased requirements for imported soybeans in 2003.   In the auto sector, China mismanaged the quota allocation system effectively denying the negotiated access.

The list of deficiencies includes:

• Questionable use of sanitary and phyto-sanitary restrictions
• Failed administration of TRQs including fertilizers, agricultural, and automotive products
• Capitalization requirements that far exceed the international norms
• Failure to provide trading rights as they affect foreign invested enterprises
• Failure to provide market access for the full range of distribution services

The list is extensive and demonstrates that China is becoming more sophisticated in using regulations to restrict access for foreign supplied goods and services.  Given China’s success in limiting market access, China should be expected to continue the same practices unless adverse consequences result.

Checks and Balances

As I mentioned in my introductory comments, we purposely negotiated a market access agreement with checks and balances.   The checks and balances related to the Transitional Review Mechanism, provisions to take safeguard actions, and the WTO provisions to use the dispute settlement mechanism.    While China has been deficient in implementing its obligations, the United States and other WTO members bear some responsibility for those deficiencies.  Because WTO members have not exercised their rights under China’s accession agreement, the WTO has condoned China’s unwillingness to fully implement its WTO obligations.   Let me address the following specific provisions:  the Transitional Review Mechanism, WTO dispute resolution, and safeguard actions.

Transitional Review Mechanism (TRM)

The TRM has been relegated to a pro-forma session where individual countries complain about China’s failure to implement its commitments.  The present mechanism is a far cry from what was originally intended and expected by WTO members when China entered the WTO.  The original purpose of the TRM was to provide guidance and, when necessary, to apply pressure on China to implement its WTO commitments.   The TRM was viewed as a special monitoring and implementation mechanism because negotiators fully realized the extent of China’s obligations and the extent to which its still government-controlled economy would have to change in order to conform to expectations of a market economy.  In fact, the earlier proposals would have granted greater authority to the TRM in recommending sanctions if and when China neglected to follow its commitments.  However, the United States and other countries objected that such a mandate would diminish the rights of WTO members under the dispute settlement process.   The prevailing view was that the TRM would be an enhanced consultation and coordination mechanism to resolve disagreements so as not to overload the WTO dispute resolution system.

The process that has evolved bears little relationship to what was envisioned.  China has blocked any effective process whereby the relevant committees could report to the WTO council on China’s implementation of its accession commitments.  Because the WTO process operates under consensus, China has been able to prevent any substantive review by WTO members on the consistency of its laws and regulations to WTO obligations.  In effect, China has laid down the gauntlet:  the TRM process will not be used as a mechanism to force China into revising its laws to conform to the expectations of WTO members.  China views the TRM process as discriminatory against China because no other acceding county was obligated to incorporate such a provision.   WTO members, on the other hand, believe the mechanism was a necessary compromise because China was acceding to the WTO prior to implementing its laws and regulations, a concession that no other country has received.  

Dispute Resolution

The net effect is that China has challenged WTO members to use dispute resolution as the balancing mechanism.  And to date, WTO members have not risen to the challenge.  The reasons are legion. 

• For small economies, concerns about Chinese retaliation are real especially because their narrow range of traded goods leaves them vulnerable to Chinese pressure and unofficial sanctions.  

• For larger economies such as the United States, the EU, and Japan, the diversity of views within each industry makes a WTO challenge difficult.  For example, the quota allocation system for automotive vehicles never were implemented as expected with quotas allocated in small quantities to holders who would never use the quotas, and then, never significantly reallocated.  However, a WTO dispute settlement challenge was difficult, given that, first, most countries had companies producing in China and thus benefiting from the unfilled quotas and second, most countries recognized that the 18 to 24 month dispute resolution process would not be worth the effort since quotas would end in 2005.  While the automotive industry is only one example, similar commercial considerations argue against governments bringing dispute settlement charges against China in the WTO.  

• Other countries simply hide behind the United States.   Both the EU and Japan are unwilling to initiate a dispute settlement case against China.  Both recognize that they too are subject to retaliation in the form of lost contracts for products like aircraft and telecommunications projects. 

• Commercial and now foreign policy concerns also prevent the United States from initiating a case.  The most likely one would deal with the VAT rebate system that discriminates against imports of foreign semiconductors and other products such as metal products.  Deputy USTR Shiner has indicated that the United States is close to making a decision on such a case.  According to press reports, Ambassador Shiner has said that if further bilateral consultations fail to break the current impasse, the United States may have to seek further consultations in the WTO.  It is unfortunate that consultations beget consultations but rarely dispute resolution.

The failure of WTO members to use the dispute settlement process means that China has a carte blanche in deciding how it implements its WTO obligations.

Safeguard Actions

China’s accession agreement includes two product-specific safeguard mechanisms, one for textiles and the other for all products, including textiles.  The principle differences between the two are the duration of protection and the mechanism for seeking approval.   For textile safeguards, petitions are filed with the Commerce Department and the remedy lasts for one year.  For the product-specific safeguards, or section 421, petitions are filed with the International Trade Commission and, if the President grants relief, Chinese imports can be restricted for up to three years with no retaliation, and longer, with the possibility of retaliation.

While the Administration has recently used the textile safeguard mechanism, the United States and other WTO members have failed to use the product-specific safeguard mechanism.   The textile provision was actually negotiated prior to the accession agreement in the bilateral textile agreement and was then incorporated into the accession agreement.   The purpose of the textile provision was to address market disruption that could occur as China’s textile trade was integrated into the phase-out of the textiles agreement.   We are seeing that the use of the textile safeguard provision is having a positive impact on China’s willingness to explore options that would create a more orderly transition for China.  U.S. producers have proposed that China and the United States negotiate a broader range of solutions in exchange for avoiding future textile safeguard actions.   In short, the use of the safeguard provision may be effective in achieving solutions that create a more orderly transition to avoid market disruption.

Conversely, the general product-specific safeguard provision – section 421 of our domestic laws – has not been used by the United States or other WTO members.   Unlike the other checks and balances in the accession agreement, this provision differs in that its purpose extends beyond the scope of implementation.  The purpose of the product-specific safeguard action was to provide temporary relief to industries that suffered market disruption due to competition from China.  As a non-market economy country, China, like many Eastern European countries and Russia, does not possess the market mechanisms to bring supply and demand into equilibrium.  Thus, its economy tends to create excess capacity and to overproduce, flooding markets in other countries.   Even if China fully implementing its WTO obligations, industries in market economies will require temporary protection until those Chinese industries, developed and operated under a non-market environment, learn to adjust and to bring their capacity and production in line with market conditions.

To date, five cases have gone before the International Trade Commission.  The first two cases on pedestal actuators and wire rod for coat hangers were denied relief based on a determination by the President that relief was not in the national economic interest.  In the third case, the International Trade Commission (ITC) denied relief.   In the fourth case on ductile iron waterwork fittings -- a case that was brought by my firm, Collier Shannon Scott -- the ITC found unanimously in favor of relief, and the interagency process is now reviewing the case in order to make a recommendation to the President.  A fifth case on innersprings is currently before the International Trade Commission.

A failure to use the product specific safeguard provision by the United States and other WTO members is a failure to allow the checks and balances of the agreement to work.  While I have been assured that this Administration recognizes that the product-specific safeguard mechanism is not limited to cases where China has failed to implement its commitments, I am not sure that other WTO members are prepared to use the mechanism so broadly.  We, the negotiators, intended that provision to go beyond implementation issues.  It was intended to address the fundamental inequities when a non-market economy country like China joins a multilateral trading system that depends on the efficient operation of market mechanisms.  Simply put, even if China were to fully implement its commitments, the market distortions in China would negate the benefits of China’s market opening measures.  As a result, Chinese industries would flood WTO markets and ultimately undermine the trading system.

In short, I have been surprised that neither the United States nor the other WTO members have used the product-specific safeguard measures or the dispute settlement process.  As long as the United States and other countries fail to use these checks and balances, China will continue to fall short of its WTO obligations and the Trade Review Mechanism will only be used as a debating forum, not as a the mechanism to solve implementation problems as originally intended by the negotiators.  We have heard much about accountability in the United States in recent years, for example, in education and in corporate accounting.  We must hold China accountable for opening its market as originally intended and expected and as China agreed.

Agreement Deficiencies

Internal Barriers to Competition

While effective use of the checks and balances of the agreement is essential, we must also look beyond the agreement to determine whether other conditions exist that, in effect, nullify and impair the benefits that we and China expected from the agreement.  During one of my trips to China, a student asked me what I would do differently if I had the chance to renegotiate the market access agreement.  Like so many others, I felt that the 1999 bilateral agreement struck the right balance of what was possible and what was necessary to get China into the WTO and grant it Permanent Normal Trade Relations status.  Nevertheless, one element that was completely lacking in the agreement -- and that would have greatly enhanced the benefits of the WTO accession package -- was a provision to open the internal markets for both Chinese and foreign goods.  China needs inter-provincial commerce legislation that would eliminate the barriers to trade among and within the provinces.  China’s internal market is riddled with barriers.  For example, the combination of provincial barriers in the form of tolls, shakedowns, outright prohibitions on using the roads, labor problems in loading and unloading freight, and the lack of an adequate road and rail system make it difficult for companies to establish an efficient nationwide distribution system.  According to the American Chamber of Commerce in Shanghai, these barriers can add about 16 percent to the cost of the product compared to roughly 4 percent in developed countries. 

The Commission should consider recommendations that urge negotiators to go beyond the confines of China’s WTO accession agreement such as inter and intra provincial trade restrictions.   This is also an excellent area for cooperation with other trading partners.  For example, the EU’s internal integration gives it special experience that would serve as a good starting point for negotiations.  Trade negotiators need to take a broader look at Chinese internal restrictions that directly and indirectly affect the ability of both Chinese and foreign goods to enter local markets.  As long as these barriers continue to restrict internal distribution, China will continue to generate overcapacity and will continue as an export platform, creating market disruption, and eventually trade disputes.

Currency Manipulation

Another area that the Commission should examine is China’s manipulation of its exchange rate.  To understand its significance, we need only look at the recent history of the Yuan to see that currency alignments have had a significant effect on China, the rest of Asia, and the world.  In 1994, China unified its exchange rates and pegged it to the dollar at 8.28 Yuan to the dollar with a very narrow band of about 0.3%.  That realignment of exchange rates initiated a realignment of trade and employment.  Jobs in other parts of Asia went to China and the relatively small trade deficit with China began its ascent to the stratospheric levels it has reached today.   Following the trend in employment, the U.S. trade deficit with the rest of Asia began to decline.  Deficits with Southeast Asia and Taiwan declined, and the deficit with Korea actually turned to a surplus.   This was the beginning of the Asia Financial crisis of 1997-98.

Other Asian countries, particularly Japan, Korea, and Taiwan, have now aligned their currencies with the Yuan and the dollar in order to protect their trade balances.  As a result, all those currencies have become undervalued with respect to the dollar.  Because of the peg, the depreciation of the dollar on international markets has resulted in little or no adjustment in trade with China or other Asian countries.  It has also forced all the adjustment in exchange rates onto the Euro, the British Pound, and other floating exchange rates.  Like the realignment of exchange rates in 1994, the current situation is unsustainable.  And like the Peso crisis and the Asian Financial crisis, the international trading system cannot wait until a global financial bubble bursts.

All experts agree that China’s currency is undervalued.  Estimates range from The Economists’ Big Mac index of 56% to more modest levels.  The Fair Currency Coalition believes the currency to be overvalued by as much as 40%.  As a result, China is amassing foreign exchange reserves to protect the peg.  Reserves have grown to $400 billion, or about 30 percent of China’s Gross Domestic Product and China has indicated that it will use some of these foreign exchange reserves to bail out its banking system.   Our trade deficit with China is essentially being used to provide direct relief to the banking system and indirect relief to the highly inefficient state-owned enterprises that China’s banking industry underwrites.   The irony is that the United States and other WTO members are reluctant to use safeguard measures to provide relief to their own domestic industries that are suffering from market disruption caused, in large part, by Chinese overcapacity.

China’s currency manipulation creates an unfair burden on manufacturers.  China earns less in dollars on its exports and pays more for its imports priced in dollars, thus impeding U.S. exports.   As the dollar depreciates against other currencies, the exchange rate with the Yuan never changes -- contributing to a continuing rising deficit with China.  Thus, the Fair Currency Alliance, a coalition representing industry, agriculture and labor, has engaged my firm, Collier Shannon Scott, to prepare a section 301 petition against Chinese currency manipulation.  The FCA’s hope is that the Administration, by accepting the case, will gain leverage with China to bring substantially revalue the Yuan and thus bring its currency into alignment with underlying economic conditions.   The examples of the Peso crisis and the Asian Financial crisis have taught us that failure to address unsustainable exchange rate alignments will create global financial crises unless addressed early and significantly.

Conclusion

In summary, any examination of the implementation of China’s agreement to join the WTO and the monitoring of those commitments should encompass not only a detailed assessment of the specific commitments but, equally important, it should encompass how the checks and balances of the agreement have been exercised.    In the absence of challenges in the form of dispute resolution and safeguard actions on the part of WTO members, China will not be compelled to use the Trade Review Mechanism to resolve disputes or to implement its obligations in the rigorous manner that Congress intended.  In addition, the Commission should extend its examination beyond the specifics of the accession agreement itself to encompass measures in China that effectively nullify and impair the benefits that the United States expected.  Chinese internal barriers to commerce and China’s currency manipulation should be the highest priority of the Commission.

Thank you.