• With a virtually inexhaustible supply of low-cost labor and large inflows of foreign direct investment (FDI) accompanied by transferred manufacturing facilities and technologies, China has positioned itself as a global export platform. China runs trade surpluses with most of the industrialized world and has been the recipient of transplanted manufacturing capabilities from the United States, the European Union, Japan, and Taiwan, among others.

• The United States has been a major contributor to China’s rise as an economic power. As China’s largest export market and a key investor in the Chinese economy, the United States has helped China become a global manufacturing center and an increasingly important center for research and development (R&D). The result of this trade and investment has enabled China to accumulate large U.S. dollar reserves. In addition, U.S. universities, laboratories, and industries have trained many thousands of Chinese scientists who have aided in a massive transfer of technology and know-how to China.

• The United States trade deficit with China is not only our largest deficit in absolute terms, but it is the most imbalanced trading relationship the U.S. maintains. In 2000, U.S. trade with China was only 6 percent of total two-way U.S. goods trade, but the U.S. deficit with China accounted for 19 percent of the total U.S. trade deficit. U.S. imports from China were over 41 percent of China’s total exports, but U.S. exports to China were only 2 percent of total U.S. exports to the world. Both the EU and Japan import much less from and export much more to China than does the United States. Some U.S. exports are lost due to China’s politicization of trade. The Commission finds there is plausible evidence that the burgeoning trade deficit with China will worsen regardless of China’s entry into the World Trade Organization (WTO).

• During the 1990s, the U.S. trade deficit with China grew to alarming proportions — from $11.5 billion in 1990 to $83 billion in 2001. Most U.S. imports from China over the past decade have been the product of low-skilled, labor-intensive manufacturing industries. However, this trend has begun to shift rapidly -- China's exports of advanced technology products (ATP) to the United States have sky rocketed from virtually zero in 1990 to $13.3 billion in 2001. The United States is now running a trade deficit with China in a majority of the items on the ATP list compiled by the Commerce Department. The U.S. Government’s ability to identify vulnerabilities and dependencies of our military-industrial base is complicated by global supply chains and limited by insufficient data. The Commission is concerned that the United States may be developing a reliance on Chinese imports that might in time undermine the U.S. defense industrial base.

• U.S. FDI into China has resulted in increased foreign affiliate sales in the Chinese market and increased related party imports back into the U.S. market. Globalization has increased the trend towards subcontractors outsourcing key components and multinational companies utilizing China as an "export platform". Over 90 percent of the FDI attracted to the U.S. was for the purpose of acquiring ownership of existing U.S. businesses. The opposite is true for FDI flows into China where estimates indicate that 90 percent of FDI is destined to establish new operations. In short, U.S. capital and Chinese labor are manufacturing products in China for both the Chinese and American markets. U.S. manufacturing workers are increasingly displaced.

• Investment in R&D has been a growing component of U.S. investment agreements with China. There has not been adequate U.S. Government oversight or analysis of these investments and their impact on U.S. economic and national security interests.

• Under the WTO, China has agreed not to condition investment or import approvals on performance requirements, including transfer of technology or requirements to conduct research and development in China. China’s full compliance with these obligations is in the U.S. national security interest.

• Over the past decade, China’s import and investment policies have promoted technological modernization in their industrial and military sectors. The United States has been a key target of China’s efforts.

• China is a conspicuous abuser of human rights, labor rights and the environment and its refusal to follow international standards in these and other areas gives them an unfair competitive advantage vis-à-vis U.S. workers and businesses.

• Continuing trade surpluses, vast investment inflows, and very high foreign exchange reserves are evidence that China is manipulating its currency by holding down its value thereby gaining an unfair trade advantage that increases the U.S. trade deficit.

• The State Department has informed the Commission that the large number of Chinese students, scholars, and researchers present in the U.S. academic and industrial establishment is a principal means used by China to acquire U.S. science and technology. The U.S. Government has limited knowledge of their number, backgrounds, and activities.

Over the past two decades, China has emerged as a major participant in the international economy. China’s two-way international goods trade grew from roughly $28 billion in 1982 to $510 billion in 2001. In 2000, Mainland China was the world’s seventh largest goods exporter ($249.3 billion) and eighth largest importer ($225.1 billion).¹ During the mid- to late 1990s, China became one of the world’s largest recipients of foreign direct investment (FDI). According to Chinese statistics, FDI flow into China in 2001 was a record $46.8 billion. To accomplish such sustained growth in exports and investment over the past decade, China’s leadership targeted technological modernization as the main pillar for such growth and steered the country’s trade and investment policies to support that objective.

The importance of the United States to China’s economic growth during the past decade cannot be overstated. The United States is China’s biggest export market, a key investor in its economy, and a principal source of technology and know-how. Since trade relations resumed in 1978, overall U.S. trade with China has grown from $1 billion to $119.5 billion in 2000. From 1990 to 2000, the U.S. direct investment position in China grew from $354 million to $9.58 billion, according to U.S. Government figures. The U.S. capital markets have also been an important source of capital: the Chinese have raised approximately $20 billion dollars over the past three years.²

Unfortunately, the U.S. role in China’s economic growth has some negative implications for the U.S. economy. From 1990 to 2000, the U.S. goods trade deficit with China grew seven-fold from $11.5 billion to $87 billion and surpassed Japan as our largest trade deficit. Such an imbalanced relationship has troubling implications for U.S. jobs and wages, as well as for the overall economic health of the U.S. manufacturing sector.

In this chapter the Commission details the uniqueness and causes of the U.S. trade deficit with China and describes the shifting composition of China’s trade toward higher technology goods. We also examine the impact of U.S. investment on China’s economic growth and technological modernization. The chapter ends with the Commission’s assessment of the national security implications of these developments and recommendations in key areas.

China has had one of the world’s fastest growing economies and has shown substantial export prowess across a wide range of goods. In just the past ten years, China has experienced rapid growth in its goods trade, with total value soaring from around $100 billion in 1990 to nearly $510 billion in 2001. China’s worldwide exports outpaced imports for all but one of those years (1993), generating annual world-wide trade surpluses, albeit not huge ones.

The U.S. Trade Deficit with China - The United States has played a significant role in helping China’s export-led growth policies succeed in a way that is not evidenced by China’s other trading relationships. The U.S. consumer goods market was the cornerstone for China’s growth in trade in the 1990s. As trade between the United States and China expanded, so too did the U.S. trade deficit. The growth of U.S. imports from China has far exceeded the growth in our exports to China. According to WTO data, in 2000, the United States took 41.3 percent of China’s total exports, while China purchased about 2 percent of total U.S. exports. From 1990 to 2000, U.S. exports to China increased from $4.8 billion to $16 billion, while imports from China leaped six-fold from $16.3 billion to $103 billion. The result has been a U.S. goods trade deficit with China that has ballooned from approximately $6 billion in 1989 to $87 billion in 2000. Notably, U.S.-China trade in manufactures accounts for virtually the entire U.S. trade deficit with China.³

Source: USITC Dataweb

The U.S. trade deficit with China is not only the largest in absolute terms, but trade with China is also the most imbalanced trade relationship the United States has with any of its major trading partners:

Source: USITC Dataweb and Commission calculations.

Trade with China represents only 6.5 percent of U.S. worldwide trade, but accounts for approximately 20 percent of the U.S. global trade deficit. As shown above, in 2001, the ratio of imports to exports in trade with China was 5.32 to 1, as compared to a ratio of 2.2 to 1 with Japan and 1.38 to 1 with the European Unition (E.U.).

Together the United States, E.U., and Japan received about 88 percent of China’s total exports in 2000, and took over 90 percent their exports in manufactured goods. However, Japan and Europe imported less from and exported more to China than did the United States. The most striking feature of U.S. exports to China is that the United States competes directly with both Japan and the E.U. and frequently comes in a distant third. In both the aggregate and at sectoral levels, the U.S. is selling less to China. Particularly stark are the relatively small U.S. sales of manufactured goods. The exceptions are aircraft and fertilizers, where U.S. sales are greater than its competitors. The skewed trading relationship raises questions not only of competitiveness, but also whether China is managing or politicizing htmects of its trading relationships.

Source: China Statistical Yearbook, various issues; compiled by USCC

The European Union’s Trade Deficit with China - The E.U. trade deficit with China was $33.4 billion in 2000; the E.U. exported $27.8 billion and imported $61.2 billion. The E.U. is selling more pharmaceutical products than either Japan or the United States does to China. The E.U., like Japan, also exports more vehicles, vehicle parts, machinery, and electrical machinery to China than does the United States.

Openness of the U.S. Market — Along with more open markets than the EU or Japan to foreign imports of many consumer goods, the U.S. has a more highly developed distribution network for imports. Significantly, a sizeable portion of U.S. imports from China is comprised of shipments to U.S. companies from their affiliates in China or from their China-based subcontractors. Increasingly, U.S. multinationals are utilizing China as an export platform in order to compete more aggressively in the global economy. While it is difficult to obtain precise figures for imports that U.S. retailers have subcontracted, there is no doubt that large U.S. retailers make up a significant portion of the import market. For example, news reports indicate that American retailer Wal-Mart alone imported over $10 billion worth of Chinese goods in 2001, equivalent to around 10 percent of total U.S. goods imports from China for that year.⁴

Comparative Advantage - U.S.-based companies may have difficulties competing in the U.S. market with some Chinese imports due to China’s low-cost labor. The Commission underscores that China’s cost advantage is in part due to the country’s lack of government restrictions on environmentally damaging commercial activities and the Chinese government’s repression of civil organizations, trade unions, and other political and human rights.

Investment and China’s Rise as an Exporting Platform - Throughout the 1990s, FDI flows into China, which have been primarily concentrated in the manufacturing sector, helped China become a world center for manufacturing and continue to have a significant impact on China’s export-led growth. The Commission has reviewed a study reporting that over 90 percent of FDI into China was for the establishment of new businesses, while over 90 percent of the FDI into the United States was for acquisition of existing U.S. businesses.⁵

The share of exports to the United States produced by foreign-invested firms has steadily increased over the last decade and a half. China required export performance as part of its investment agreements with foreign firms. In 1985, foreign-invested firms produced 1percent of China’s exports. In 1990, they produced 12.5 percent, and in 2000 48 percent.⁶ Researchers at the New York Federal Reserve Bank estimate that only 20 percent of China’s total imports reach China’s domestic markets, while the other 80 percent consist of capital goods and industrial inputs used for the country’s exporting zones.⁷ Morgan Stanley’s most recent report on the U.S. deficit with China described, the contribution of foreign enterprises to China’s export ascendancy as "nothing short of staggering".⁸ China reported a new record in FDI actually absorbed for 2001 of $46.8 billion and expects to attract over $50 billion in new FDI in 2002, with much of the new FDI focused on high-tech sectors.⁹ Just as investment in labor-intensive industries drove a dramatic rise in China’s exports in those sectors, there is a high probability that increasing investment in advanced sectors will cause exports in the higher value-added goods to continue to rise dramatically.

Also, contributing to the expanding U.S. trade deficit with China is the shifting composition of the U.S. trade deficit with Asian nations.¹⁰ In many instances, U.S. imports from China displaced low-cost goods from other Asian countries. As Chinese goods put price pressures on the labor-intensive manufactured goods from the newly industrialized countries of Asia in the early 1990s, these countries were compelled to move up the quality and value-added ladder into goods like advanced personal and professional electronics and computer-related hardware. By 2000, all of the Asian Tigers, and even Japan, began to see many of their manufacturers migrate to China where they could sell in China but also use it as an export platform to the U.S. The Commission believes this trend is important to note, and in Chapter 5 we have assessed it in greater depth.

In part, the U.S. trade deficit with China represents a shift in trading patterns between the U.S. and Asia as a whole. Many of the Asian nations have shifted some of their production to China to take advantage of the comparatively lower cost-of-production. U.S. imports from China have displaced some of the imports from these nations. The U.S. trade deficit with China accounted for 20 percent of our deficit with the Asian region in 1992, and doubled to 40 percent by 2001. The U.S. trade deficit with the entire Asian region also continued to grow during this same time period from $91.7 billion to $212.5 billion.

U.S. Investment and Growth of Related Party Trade — Running counter to the traditional trade policy view that investment leads to trade, the increasing amounts of investment into China by U.S. firms appear to be contributing to the widening U.S. trade deficit. Many U.S. companies make products in China and then export them back to the U.S. or export them to other countries (thereby displacing U.S. exports to those countries). Related party trade (trade between a company and its foreign affiliate) as a subcomponent of U.S.-China trade has grown dramatically. According to U.S. Department of Commerce data, around 18 percent of U.S. imports from China in 2000 came from related parties, a number that has steadily risen over the past decade. For example, as reported in a Xinhua News Agency dispatch this year: "Motorola has opened eight joint-ventures in China, a $3.4 billion investment. These joint-ventures exported over $1 billion worth of goods last year, making Motorola the largest exporter among China’s foreign-invested firms."¹¹ Motorola plans to increase its total investment in China to $10 billion by 2006¹². As Motorola’s investments and production in China have increased, it has reduced employment at its U.S. facilities.

Source: USITC Dataweb, U.S. Bureau of Economic Analysis; compiled by USCC Staff

# Percentage of Imports due to Related Party Trade

Lack of Market Access to China - In part, the U.S. trade deficit with China results from a market that has been relatively closed to U.S. goods through restrictive tariff and non-tariff trade policies, as well as the politicization of its trade policies. China has closely guided its import policies to support its growth objectives. Despite attempts throughout the 1990s by the U.S. and other foreign governments to gain greater market access in China for their domestically produced goods, much of China’s imports have been inputs for assembly and re-export. Although China reduced tariffs from an average of 43 percent in 1994 to an average of 15 percent by the end of 2001, the government and state-owned enterprises sought protection through a series of non-tariff barriers targeted at imports not related to re-export trade. As one witness told the Commission: "(O)f even greater significance to our trade deficit with China are the costly and burdensome non-tariff barriers which confront our companies. These barriers take many forms, from a distribution system which discriminates against our companies, to the discriminatory buying practices of state-owned enterprises, to the arbitrary customs procedures we face at the ports-of-entry."¹³

The United States, as well as China’s other major trading partners, supported China’s entry into the WTO in part to address the non-tariff barriers and trade-distorting practices of the Chinese government and state-owned entities, with the goal of enhancing market access for their goods. But, there is no indication that China’s accession to the WTO will significantly reduce the burgeoning U.S. trade deficit with China.¹⁴ In testimony before the Commission, representatives of the Bush Administration made clear that reduction of the U.S. trade deficit with China was not a necessary objective of China’s accession. Assistant Secretary of Commerce William Lash stated:

Currency Manipulation - The exchange rate of the Chinese yuan (or Renminbi) to the dollar is also an important contributing factor to the U.S. deficit. While the United States has a free-floating exchange rate in which official intervention is both rare and done in small amounts, China holds a soft peg to the dollar with its currency nonconvertible on the capital account. In 2001, despite the country’s $23 billion global trade surplus and FDI inflow of $46.8 billion, China maintained its soft peg. China accomplishes this through large official purchases of dollars in order to maintain an exchange rate lower than would otherwise occur by market forces alone. By holding down the exchange rate, China gains an unfair trade advantage that increases the U.S. trade deficit beyond what the market would dictate. Ernest H. Preeg, Senior Fellow in Trade and Productivity at the Manufacturers Alliance/MAPI, who testified before the Commission in May 2001, wrote in his testimony to the Senate Banking Committee in May 2002:

C. Fred Bergsten, Director of the Institute for International Economics, has also advocated pressuring China to change its exchange system. "Because of the exchange controls, they require the export earnings of a Chinese exporter to be sold to the central bank for local currency…I’m proposing that we suggest they not do it…The implication would then be an appreciation of the Renminbi and some modest depreciation of the dollar." The Commission believes China’s currency manipulation needs to be addressed and that the Chinese should be pressured to change their exchange rate policy and eliminate capital controls. Moreover, while it is not presently in China’s interest to use its very large dollar reserves as an economic weapon against the U.S., in the future, this possibility exists. The Commission will continue to monitor this issue.

The bulk of U.S. imports from China over the past decade have been labor-intensive and low-skilled assembly manufactured products. While these products still dominate U.S.-China trade and the absolute size of China’s surplus in this area is growing dramatically, the composition is shifting.¹⁸ China is now also exporting to the U.S. higher value-added manufactured goods and an increasing amount now qualify as Advanced Technology Products (ATP).¹⁹ A Commission study has found that China’s rapid technological and economic success and its unique overall trading relationship with the U.S. is a strong, contributing factor to China’s shift toward exporting more ATP goods.²⁰

Global ATP trade has historically been one of the areas of U.S. strength, even as manufactured goods trade fell to record deficits during the past decade. However, the export advantage that the U.S. enjoyed in ATP trade with China in 1990 was lost by 1995, and the U.S. has seen a general trend of broadening and deepening ATP deficits with China every year since. In less than a decade, China, in its trade with the U.S., has shifted from being a net importer of ATP goods to a net exporter. While U.S. ATP exports to China grew by 483 percent between 1990 and 2001 ($1.24 billion to $7.24 billion), Chinese ATP exports to the United States increased 8,126 percent (from $0.16 billion to $13.36 billion) and accounted for 6.8 percent of all U.S. ATP imports. China’s shift in trade composition has widened the U.S. trade deficit for ATP goods with China from $1 billion in 1995 to $6.95 billion in 2000, (easing to $6.12 billion in last year's U.S. recession and technology slump but soaring by 40 percent for the first quarter of 2002). The United States now runs a deficit with China in almost two-thirds of the 650 individual ATP product lines tracked by the Commerce Department.²¹

In 2001, bilateral technology trade was primarily (more than 99 percent) in four product areas: Mechanical Equipment including Computers (46 percent); Electrical Machinery (35 percent); Aircraft and Spacecraft (12 percent); and Optical-Photographic and Measuring Equipment (almost 7 percent). Among these product areas, between 1997 and 2001, the U.S. deficit with China increased by $5.4 billion for the first two categories, while the U.S. trade surplus in the later two categories increased by less than $500 million.²²

China is increasing capital investment in manufacturing capacity for advanced telecommunications and information technology products (such as silicon wafers) that are likely aimed at export to the United States.²³ The trends in the computer and peripheral equipment industries suggest U.S. reliance on Chinese manufactured components in such products is increasing. As noted by one financial analyst report, "China consumes 6 percent of global integrated circuit demand but only produces 1 percent itself; having moved operations to China, multinational corporations are demanding suppliers join them. China’s integrated circuit sector is just emerging."²⁴ The trend in the telecommunication industry also suggests the manufacture of Chinese components is increasingly important.

According to a report on China’s WTO agreement contracted by the Commission, the inability of import-sensitive sectors to compete with Chinese imports can raise import dependency issues and, by implication, national security concerns. China has shown an extraordinary ability to rapidly expand production and exports in a wide range of products. It is unclear how much of this success flows from government subsidies and closed domestic markets. To date, the United States has paid little attention to dependency on imported products from any one nation, including China.²⁵

The Commission has found that U.S. government data are currently inadequate to track properly industrial-technological-military dependencies. The Harmonized Standard codes, used by the U.S. Customs Service, and the Military Critical Technologies List, are impossible to cross-reference due to the insufficient specificity of both lists. Without the ability to cross-reference these lists, analyses of U.S. technological and military dependencies on imports from China are deficient. With globalization, sub-contractors are outsourcing key components. In 1992, the U.S. Navy and the Commerce Department traced the sourcing on three major projects and found 115 distinct items where a foreign dependency existed.²⁶ Shifts in the U.S. and world technology trade since 1992 have almost certainly increased that number.

An important factor behind the Chinese leadership’s decision to embrace WTO membership was its continuing need to attract foreign investment, especially in high-technology sectors, from the U.S. and elsewhere. Foreign direct investment (FDI) has been a critical component of China’s effort to develop its economy and advance its science and technology base. FDI both fuels China’s economic growth and enhances htmects of its military development.

Over the past decade China has become the largest recipient of FDI in the developing world and one of the world’s principal destinations for FDI. Between 1996 and 2000, almost 75 percent of China’s capital inflows ($290 billion) were in the form of FDI ($217 billion). Unlike other developing countries, China has not heavily relied on foreign loans to finance its economic modernization; in fact, new foreign borrowing declined from a peak of $12.7 billion in 1996 to $10 billion in 2000.²⁸ The model of export-led growth and import substitution policies, conducted in tandem with increasing amounts of foreign direct investment and a tightly controlled currency, underpinned a decade of rapid economic growth.

The U.S. has been a key investor in the Chinese economy over the last ten years, with U.S. data indicating the direct investment position growing from $354 million in 1990 to $9.58 billion in 2000. Including Hong Kong, the gateway by which many U.S. firms gain access to the mainland, China became the preferred location of U.S. FDI not only in Asia but also among other developing nations. Only Mexico (as a result of NAFTA) and Brazil attracted more U.S. investment among the developing nations than China/Hong Kong over the second half of the 1990’s, and in 2000 China overtook Mexico as the U.S.'s largest investment target.²⁹ Increasingly, U.S. firms have sought not only market access with their investments, but also low-cost manufacturing platforms to better compete in the global market.³⁰ According to Morgan Stanley, "China’s massive consumer and labor markets do set it apart from the rest of the world, and for many U.S. firms, there is simply no choice but to be on the ground there."³¹

Source: United States Bureau of Economic Analysis data compiled by USCC staff

Over 400 of the world’s 500 largest companies are now invested in China, with U.S.-based firms having been the largest investors for three consecutive years. U.S. direct investment outflow to China and Hong Kong in 2000 hit a record high of $4.4 billion - a 4 percent increase over 1999 and 3.1 percent of total U.S. direct investment abroad. American corporations’ investments have been concentrated in higher value added manufacturing (electronics equipment, telecommunications equipment, transportation parts and equipment, etc.), services (insurance, financial and distribution), and petroleum, rather than labor-intensive manufactures (footwear, apparel, textiles, plastics).

Technology Transfer — With the objectives of modernization and self-sufficiency of the country’s industrial and military sectors, China’s leadership has methodically guided a remarkable drive for technological modernization.³² China’s leaders, including President Jiang Zemin, repeatedly emphasize the importance of developing independent, proprietary high-technology capabilities as a means to boost China’s economic and military prowess to counter "hegemonic" actions of the United States.³³

In an effort to develop indigenous high-tech industries, China’s foreign import and investment policies have increasingly emphasized industry-specific investment and high technology imports.³⁴ China maintains a carefully integrated set of evolving industrial policies to "encourage, permit, restrict or ban" foreign involvement in very specific areas of technology and production. These guidelines were designed to encourage foreign investors to move away from labor-intensive projects towards joint-ventures in advanced technology, modern infrastructure development and high value-added goods. Beijing is also encouraging investment in the Western part of the country- raising concerns regarding joint partnerships with the many defense-related firms located in those inland regions.

In April 2002, the Chinese government issued its latest investment policy document, titled "Catalogue for Guiding Foreign Investment in Industry." The list of encouraged sectors grew by nearly 70 categories, while the list of restricted sectors grew by six categories. Most of the additional encouraged sectors were in manufacturing of advanced biotechnology, materials, electronics, communications equipment, and machine tools and manufacturing systems. Clearly, the identification of these sectors reflects the Chinese government’s intent to direct foreign investment, management, and production technologies toward advanced manufacturing sectors.

Prior to agreeing with its WTO obligations to cease such practices, China’s laws, regulations and policies with regard to foreign investment and trade included numerous provisions and mandates for foreign technology transfer. Technology transfers have also been used as a deal maker by U.S. firms seeking joint-venture contracts. The most significant offset initiative put forward by U.S. high-tech companies in seeking approval for joint-venture manufacturing partnerships or facilities in China is the establishment of an institution, center, or lab devoted to joint research and development (R&D).³⁵

In 2001, China’s Academy of Sciences identified 124 high-tech R&D centers in China that had been set up by foreign firms. A large number of global technology firms have at least one R&D center working jointly with Chinese state controlled firms and universities, signifying a shift for multinational companies that had previously withheld their R&D work from China.³⁶ As China increasingly becomes a center for R&D, more technology transfer will occur and thereby threaten the U.S. domestic R&D base.³⁷

The rate of U.S. investment in R&D in China by U.S. majority-owned foreign affiliates has increased significantly over the past two years. In 1997, U.S. firms invested $35 million in China and $14.5 billion worldwide for R&D. In 1999, investment jumped to $305 million in China (a 771 percent increase) - $292 million invested by manufacturing firms, and $26 million of that by chemical firms- and $18.3 billion worldwide (a 25 percent increase) for R&D.³⁸

The scope and the nature of research done in China are advancing very rapidly.³⁹ As Alcatel’s executive vice-president Ron Spithill recently told the Financial Times, "Very soon (China) will be a source of innovative technology."⁴⁰

According to the Department of Commerce commissioned report U.S. Commercial Technology Transfers to the People’s Republic of China, Chinese officials "frequently play foreign competitors against one another in their bids for joint-venture contracts and large-scale, government funded infrastructure projects in China. The typical result is usually more technology being transferred as competitors bid up the level or type of technology that they are willing to offer."⁴¹ The report also stated: "…it is clear that foreign firms are being coerced into transferring technology (which they probably would not otherwise do) as the price to be paid for access to China’s market."⁴²

The American Chamber of Commerce in China (AmCham-China) explicitly expressed its skepticism in its annual white paper in 2001: "Despite the updating of provisional regulations on technology licensing in preparation for China’s WTO entry, foreign companies are still required to submit technology licensing documents to the Chinese government for review — and licensors often must trade significant technology rights for approval to continue their project. In some industries, informal administrative measures in the form of ‘advice’ to foreign companies make technology transfer a pre-condition to market entry. AmCham-China strongly believes China needs to take a more progressive and open approach to end such irregular practices."⁴⁵

The significance of these arrangements is profound. In a recent report to Congress on U.S.-China Science and Technology Cooperation, the State Department concluded: "This Chinese investment strategy, designed to extract technology transfer from American firms as a condition for entering the Chinese market, is, in State’s estimation, the principal source of technology transfer from the U.S. to China."⁴⁶ State goes on to say that China "reaps a technology bonanza" from these investment policies. And, this trend will most likely continue, if not accelerate. The Chinese Academy of Sciences recently detailed a study that found that in 1997 only 13 percent of foreign firms in China applied the parent company’s most advanced technologies in China. By 2001 that proportion had already risen to 41 percent and the Academy expects it will exceed 50 percent in 2002.⁴⁷

Foreign Nationals Studying in the United States - The Commission finds that another principal means China is using to channel scientific and technological information to China is through Chinese foreign nationals studying and working in the U.S.

The recent State Department-coordinated report U.S.-China Science and Technology Cooperation concludes:⁴⁸

• it is clear that a major facilitating channel for the flow of scientific/technological information and know-how from the U. S. is the vast number of Chinese students annually present throughout the U.S. higher education system;
• it is State’s belief that the large numbers of Chinese students, scholars, researchers and high-tech workers, ubiquitously present throughout the U.S. academic and industrial research establishment, collectively represent China’s chief means of gathering information on U.S. scientific and technological development;
• viewed against the context of what China can glean from the proliferation of its nationals working in U.S. laboratories, whatever knowledge China might possibly have gained from cooperative S&T activities conducted under the 1979 S&T agreement would be negligible by comparison.

Of particular importance is the fact that the large majority of these Chinese students are engaged in courses of study or research in fields related to mathematics, science and technology.⁴⁹ In 1999, 8 percent of the doctorates awarded in the United States in the sciences and engineering went to Chinese foreign nationals while U.S. citizens accounted for 22 percent of the doctorates.⁵⁰ The Commission emphasizes the State Department finding that "U.S. academic research laboratories throughout the country are hosts to thousands of Chinese students and researchers who have first-hand knowledge and participation in some of the most advanced S&T research projects across a spectrum of scientific disciplines. Many of these students return to China, taking their knowledge and expertise obtained in U.S. labs with them. Many others remain in the U.S., working in U.S. high-tech industry or remaining in academia."⁵¹ U.S. high-tech firms, where the latest technologies are being developed, apparently also employ "thousands" of Chinese who have completed their studies in the United States, largely because they are unable to find sufficient numbers of S&T trained Americans. ⁵²

The U.S. Embassy in Beijing reports that it issued over 9,000 H1-B visas to Chinese in FY2001 for working in these high-tech firms.⁵³

As with all foreign students studying in the United States, the U.S. Government has very limited knowledge as to their numbers, backgrounds, and activities here. In many cases, the U.S. Government loses track of them.

According to the Institute of International Education’s "Open Doors On the Web," there were 59,939 Chinese students in the United States in the 2000/2001 academic year, a 10 percent increase over the previous academic year. Constituting the largest percentage of foreign students studying in the U.S., Chinese students accounted for 10.9 percent of all foreign students.⁵⁴

The Commission recognizes that the U.S. high-tech community depends on the talent of foreign nationals, and similarly, that the size and configuration of the U.S. college and university system assumes that there will be large numbers of foreign students. Furthermore, the Commission values and recognizes the importance of exposing foreign nationals directly to our democracy and freedoms. However, the Commission believes that the lack of oversight of Chinese foreign nationals, as well as those of many other countries, studying and working in sensitive disciplines can have serious national security implications. The transfer of "know how" could potentially be applied to China’s military industrial base. Consequently, the Commission concludes that increased oversight, review, screening and tracking of Chinese foreign nationals studying and working in the U.S. is necessary, and we support the recently signed into law "Enhanced Border Security and Visa Reform Act of 2002". The Commission stresses the importance of implementing and enforcing the law’s provisions that seek to improve efforts to track foreign students in the U.S. to ensure that they maintain their appropriate visa status.

There has been considerable debate over the impact that the U.S.-China economic relationship has on wages and employment levels in the United States. Evaluating the economic relationship with China is not only a matter of understanding the merits and drawbacks of free trade and globalization, but also involves questions of fair competition and American values. There are serious implications in exposing U.S. workers to competition with China - a non-market economy that is a conspicuous abuser of human, political, and labor rights and the environment.

A key question that the Commission’s contracted research and public hearings have repeatedly raised is whether U.S. trade and investment with China are adversely impacting are not only wages and jobs in traditional manufacturing areas, but those in high-technology industries as well. Paul Craig Roberts, an economist and columnist, who served as an Assistant Secretary of Treasury in the Reagan Administration, recently wrote: "The upshot is that both American and Chinese firms produce for the U.S. and Chinese markets with Chinese labor. U.S. labor is not in the picture."⁵⁵

While numerous arguments have been presented to the Commission that the U.S. economy benefits tremendously from its trade with China, we have also heard from labor representatives about the dislocation and virtual stagnation or decreasing standard of living that many U.S. workers face. The impact of trade with China on U.S. security interests — both military and economic — is complex. There are positive and negative htmects to the relationship which all parties must recognize in order to allow reasoned analysis and debate. In the opinion of the Commission, however, simply to accept a "business as usual" approach is not acceptable.

Through the course of three hearings on the impact of the U.S.-China trade and investment relationship on key American industries, the Commission heard a variety of opinions on the contentious topic of globalization. The Commission heard from academics such as William Overholt, a Senior Fellow at Harvard University Asia Center, about the benefits of the U.S.-China trade relationship:

The Commission heard of a different side of the relationship from labor representatives such as Richard L. Trumka, Secretary-Treasurer of the AFL-CIO:

While the overall American economy experienced great growth and prosperity in the 1990s, not all workers or sectors of our economy benefited equally. The Commerce Department has argued that each $1 billion in exports creates 11,000 to 20,000 jobs. The Economic Policy Institute has stated that each $1 billion in imports may also cost 11,000 to 20,000 jobs. Hundreds of major U.S. brand name companies now manufacture in China and are no longer part of American communities producing jobs for American workers. The Commission heard from William Wolman, Chief Economist of Business Week: "Because U.S. imports have been growing faster than U.S. exports, it is likely that the international position of American workers is not improving but deteriorating. That is a major reason why there is no end in sight to wage stagnation in the United States and in other industrial countries."⁵⁸

The Commission has heard that this trend of wage stagnation is not exclusive to blue-collar jobs but seems set to move into white-collar jobs as well.⁵⁹ While the Commission notes the low level of unemployment the U.S. has enjoyed, we are troubled that many Americans have not only been left out of wage increases but have in fact suffered wage decreases.

Implications of Competition with Chinese Workers - Many of the labor representatives that testified before the Commission detailed the implications of American workers competing with Chinese workers in a "race to the bottom". Pointing at the unfair competition implicit in Americans competing against Chinese workers who have been denied fundamental human rights such as the right to organize and collectively bargain, labor representatives such as Leo W. Gerard, International President of the United Steelworkers of America (USWA), have explained:

Lack of Adequate Data — Due to the inadequate statistics currently available, an accurate understanding of the wage and employment effects of the U.S. trade and investment relationship with China is difficult. In particular, while there are numerous statistics detailing how globalization is holding down inflation and increasing the profitability of U.S. corporations, there is a dearth of information regarding precisely how globalization is effecting American workers in the manufacturing and low-wage service sectors.

In part, the statistical inadequacies result from political bias. For example, during the Congressional debate on Permanent Normal Trade Relations with China, the Clinton Administration chose to release data on export sales state-by-state. In part, they extrapolated what the job gains would be for each state based on the rough estimate by the Commerce Department that each $1 billion in exports creates 11,000-20,000 jobs. At the same time, the Administration did not release import statistics on a state-by-state basis that would provide a clearer picture of the impact of the increased trade on job losses. Another example is the decision by the Department of Labor to stop releasing trade adjustment data sorted by zip code for fear that opponents of Administration policy initiatives would use the data to highlight the "cost" of Administration trade policies.

In an effort to overcome these statistical inadequacies, the U.S. Trade Deficit Review Commission contracted with Professor Kate Bronfenbrenner at Cornell University’s School of Industrial and Labor Relations to complete a study that provided empirical findings through the use of a media-tracking system. The study tracked all media-reported production shifts out of the U.S. to China, Mexico, and other Asian and Latin American countries and out of Asian and Latin American countries into China that occurred between October 1, 2000 and April 30, 2001. The information was combined with macroeconomic data on imports, exports and investment. The study is the first and only national database on production shifts out of the U.S.⁶¹

Professor Bronfenbrenner detailed the study’s key findings in her testimony before the Commission:

Other significant highlights of the research were:

The Commission believes that the U.S. Government needs to establish a federally mandated corporate reporting system that requires companies to report the presence and shift of production both from within the United States to overseas and from one overseas location to another. A thorough understanding of the impact trade and investment policies have on employment, workers, wages and communities, requires more information on such matters to allow policymakers to make informed decisions.

U.S. Supported Funding of Overcapacity - The Commission is also concerned about the impact on American workers of the U.S. Export-Import Bank and international financial institutions’ (IFI) assistance to China. China accounts for approximately $6 billion of Ex-Im Bank’s exposure, the largest of any country. China also has the largest portfolio in the World Bank, standing at $34.8 billion in commitments.

The most notable case of U.S.-support for funding global overcapacity has been Ex-Im Bank’s guaranteeing of an $18 million medium-term loan to support the $21.7 million export of equipment and services by General Electric and other U.S. suppliers to the Benxi Iron & Steel Co. in Benxi, Liaoning, China. The Commission heard from representatives of the steel industry about the effect of Ex-Im Bank’s guarantee to Benxi as well as their concerns about the implications for further action. As Leo W. Gerard, International President of the United Steelworkers of America testified:

The issue becomes more complex when one considers that the guarantee to Benxi Iron & Steel directly supported 300 union jobs at GE’s 1,600-employee Salem, VA plant, and represented 10 percent of the plant’s production.⁶⁵ Regardless, Ex-Im Bank agreed to reassess its economic impact procedures. In addition, the recently passed Export-Import Bank reauthorization bill prohibits the Bank from providing financing that would be used by foreign entities to produce a product that is the subject of an antidumping or countervailing duty order. Entities that are the subject of a preliminary determination will be required to undergo an economic impact assessment before receiving Ex-Im financing.

While the effectiveness of the new procedures remains to be seen, there appears to have been little spillover on this topic to the examining of U.S.-supported international financial institutions (IFIs). The International Finance Corporation (IFC), for example, the arm of the World Bank Group that invests in the private sector, has invested in two different steel projects that are joint-ventures between Chinese and European companies: Scana Leshan Metallurgical Joint-venture Co., Ltd. and Shanghai Krupp Stainless Co., Ltd. Each project contributes to increasing global overcapacity in steel products. While these two projects may result in developing portions of China’s economy, there has been no economic impact assessment on the U.S. steel industry. China is currently the IFC’s ninth-largest country portfolio and is one of its fastest growing client countries. Without proper oversight in the form of an economic impact assessment on the U.S., U.S. taxpayers may have invested in an IFI that is harming the U.S. economy and U.S. workers.

Witnesses have expressed concern to the Commission that with over 105 million Chinese living on less than $1.00 a day and with little or no access to clean water, productive farmland, sufficient education, or adequate health services, U.S. taxpayer funding that was targeted towards poverty reduction is being diverted to increasing the international competitiveness of China’s steel industry. Witnesses have found this particularly troubling in light of China’s massive currency reserves that would be more appropriately used for improving their own steel industry.

U.S. participation in International Financial Institutions should reflect U.S. policy; in particular, U.S. delegates to the IFIs should not counter actions taken by the U.S. Government to stem the global oversupply of steel. Other important policy objectives must also be reflected in U.S. efforts at the IFIs.

The U.S.-PRC trade and investment relationship over the past decade has had serious implications for U.S. national security. U.S. policies have played an important role in helping the Chinese leadership achieve stunning economic growth and the modernization of their military industrial complex.

The large and growing U.S. trade deficits with China pose economic and security concerns for the U.S. Many observers, including Federal Reserve Board Chairman Alan Greenspan and former Treasury Secretary Robert Rubin have stated that the U.S. trade deficit is unsustainable. In 2001, the contribution of the U.S.-China trade deficit to the overall U.S. trade deficit constituted about one-fifth of the $393 billion total. As U.S. imports far outpace exports, the U.S. must finance this imbalance.

The U.S.-PRC trade relationship plays an important role in China’s ability to maintain global trade surpluses and accumulate large foreign reserves. If China’s $83 billion surplus with the United States were removed, China would have had a 2001 trade deficit of $60 billion with the rest of the world. Large trade surpluses and large net financial inflows have allowed China to build up foreign reserves that stood at $212.2 billion at the end of 2001- a one-year increase of $46.6 billion. These reserves are in addition to China’s 500 tons of gold reserves. China’s foreign reserves are now second only to Japan’s, assuring increasingly significant financial and strategic options.⁶⁷ They are particularly important to China’s military modernization, as Beijing continues to rely on hard currency to purchase advanced weapon systems abroad. The Commission is concerned with the military implications of China’s foreign reserves and discusses them in more detail in Chapter 9.

The Chinese leadership guided their trade and investment strategies with the objective of leapfrogging in developing their science and technology base. U.S. firms, to obtain a foothold in the Chinese consumer market, played a significant role in this development. With U.S. help, China has developed into a major global manufacturing center and a rising global R&D center, raising serious questions as to U.S. dependency on China for key items of our defense industrial base.

Over the past decade U.S. trade and investment policy with China has too often favored short-term commercial and corporate interests over broader national economic and military security concerns. As we move forward in the relationship, the United States needs to strike a more appropriate balance. The U.S. government should provide more oversight of U.S. firms’ R&D investment and commercial technology transfers. As well, more oversight and tracking is needed to evaluate the hollowing-out of the U.S. industrial base and to determine whether import dependencies may be developing that can undermine our defense industrial base and thereby threaten national security.

The Commission will continue to monitor and report regularly on the composition of trade and investment, shifting patterns and trends and dependencies, commercial technology transfers and R&D collaboration, and the challenges to U.S. exporters and workers.