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US-China Trade Relations

Published February 2007

The New Congress

The November 2006 congressional elections and the resulting Democratic majorities in the US Senate and House of Representatives have made trade legislation, either specific to China or more general, likely this year. The possibility that either chamber passes trade legislation is significantly greater than last year, particularly in the House of Representatives, where Democrats enjoy a sizeable majority and where procedural rules limit the ability of the minority party to affect legislative outcomes. The Senate, too, could pass legislation, but the much narrower Democratic majority and the body's rules of debate mean that substantial bipartisan support will be required for any bill to pass.

Senate

In the Senate, attention will focus initially on efforts by senators Max Baucus (D-MT), Lindsey Graham (R-SC), Charles Grassley (R-IA), and Charles Schumer (D-NY) to craft legislation to address concerns about international exchange rate policies in a manner that does not violate US commitments as a member of the World Trade Organization (WTO). The four senators agreed in September 2006 to work on this legislation, and as a result, Schumer and Graham withdrew their earlier bill, which mandated significant tariffs on imports from China unless Beijing revalues its currency and was due for a vote in the Senate.

The result--if any--of this effort remains uncertain. Aides to the four senators have only recently begun to discuss what form the proposed legislation may take. They may choose to take a bill introduced in 2006 by Baucus and Grassley as a starting point. That bill would do away with the Treasury Department's current mechanism for exchange rate monitoring, replace it with a report in which the Treasury Department identified "fundamentally misaligned" exchange rates that negatively affect the US economy, and require the imposition of sanctions on countries that refuse to adjust misaligned exchange rates. The sharpest of these sanctions perhaps would be the bill's prohibition on US support for expanding the voting rights of a country in multilateral financial institutions, such as the International Monetary Fund.

Schumer and Graham apparently are not satisfied that the recourse provided in the bill is tough enough to meaningfully pressure foreign governments to adjust exchange rates that the Treasury Department has found to be "fundamentally misaligned." Additional changes could result from discussions with members of the Senate Banking Committee, which must be included in drafting any legislation on exchange rate matters.

Hearings in the Senate Finance Committee on trade are expected to take place in February, with hearings on China to follow. The four senators are expected to complete work on their legislation by April. If they fail to do so, Baucus and Grassley agreed not to use the Finance Committee to block separate legislation introduced by Schumer and Graham.

House of Representatives

Representatives Charles Rangel (D-NY) and Sander Levin (D-MI), chairs, respectively, of the House Ways and Means Committee and its subcommittee on trade, are expected to propose trade legislation in the first half of 2007. China is a priority for the committee, and legislation to address perceived inadequacies in the bilateral trade relationship could come as part of a broader trade package or as a separate bill.

The substance of the expected legislation remains unknown. Some clues, however, may be provided in trade bills introduced by Democrats in the previous congress. In July 2005, Rangel, Levin, and others, who included Representative Nancy Pelosi (D-CA), now the speaker of the House, and Representative Steny Hoyer (D-MD), the House majority leader, proposed legislation touching upon many aspects of China trade policy. The bill would have forced the Office of the US Trade Representative (USTR) to launch an investigation of China's exchange rate policy that could have led to a WTO case and allowed for the application of countervailing duties on imports from nonmarket economies, such as that of China (see p.3). In 2006, Rangel, Levin, and a handful of other House Democrats introduced a bill that would establish a "Congressional Trade Enforcer" as an office independent of the executive branch that would issue "indictments" of trade policies of foreign countries deemed to violate WTO rules or bilateral agreements. In addition, Levin and then-Representative Ben Cardin (D-MD), who moved from the House to the Senate following the November election, introduced a wide-ranging bill that would, among other things, define "exchange-rate manipulation" as a countervailable subsidy. This move would allow US persons to petition the US government to impose import duties on specific Chinese goods to correct for the alleged undervaluation of the renminbi. It would also limit the president's discretion to determine whether to impose limits on imports from China after being recommended to do so by the US International Trade Commission.

The House Ways and Means Committee is expected to hold hearings on trade and China in February or March. Specifics of what is planned for trade legislation will likely emerge after those hearings.

SED and JCCT

The Strategic Economic Dialogue (SED) and Joint Commission on Commerce and Trade (JCCT) offer US and PRC officials the best opportunities to advance the bilateral trade relationship and resolve specific concerns, respectively. China and the United States announced the creation of the SED in September 2006, when US Secretary of the Treasury Henry Paulson made his first governmental trip to China. The SED, which held its inaugural session in December 2006, aims to be a top-level framework for promoting policies that will sustain mutually beneficial economic ties and to provide guidance and momentum to existing channels, such as the JCCT, which will remain the primary venue for resolving specific commercial problems.

To do this, US and PRC officials agreed during their talks in December in Beijing to establish three working groups under the SED and to enhance the activities of two existing working groups under the JCCT. The three new groups will focus on services, investment, and transparency. US officials traveled to Beijing in late January and early February to initiate these new working groups. In addition, SED participants agreed to invigorate existing working groups on export controls and on market economy status for China. On export controls, Assistant Secretary of Commerce for Export Administration Christopher Padilla was in China in late January for a meeting of the US-China High-Technology and Strategic Trade Working Group.

These groups are expected to meet several more times before the second session of the SED, which is expected to take place in May in Washington, DC. As in the December session, PRC Vice Premier Wu Yi will lead the PRC delegation, and Paulson will chair the US side. US President George W. Bush is expected to meet with the participants, as PRC President Hu Jintao and Premier Wen Jiabao did at the inaugural meeting.

US and PRC officials also agreed at the SED to improve bilateral cooperation on intellectual property rights (IPR) protection, travel and aviation, energy and the environment, and health care. Already, the two countries have signed a protocol intended to increase energy efficiency and the use of renewable energy in China, and negotiators from both sides met in Beijing in late January to discuss a new air travel agreement.

Paulson and other officials have repeatedly stressed that the SED is not intended to result in immediate solutions to particular trade problems. Rather, US officials hope to leverage momentum created at the SED into tangible progress in resolving trade problems at the JCCT. They therefore aim to schedule the 2007 session of the JCCT for sometime after the SED, perhaps in July. It is likely that the SED working groups will influence the issues officials choose to tackle at the JCCT.

Areas of Contention

Despite the work of trade officials from China and the United States to use the JCCT, and other bilateral mechanisms, to resolve commercial disputes, several issues appear likely to be contentious in 2007. These include cases against China at the WTO that the United States has either initiated or is known to be considering, moves by the US Department of Commerce (DOC) to apply countervailing duty laws to China, and the possible enactment of new US export controls on sales of dual-use technology to China.

WTO cases

Early in February, US trade officials initiated a WTO case challenging several export and local-content subsidies the PRC government provides to foreign and domestic companies. These subsidies come in the form of tax breaks, exemptions from some tariffs and employee benefits payments, and preferential lending terms. Some of the challenged subsidies are included in the list of more than 70 subsidy programs that China provided to the WTO in April 2006.

In April 2006, Washington filed a WTO case regarding China's tariffs on imported auto parts--a policy that US officials claim acts as a de facto local-content requirement and therefore violates China's commitments as a WTO member. In late January 2007 the WTO director general appointed dispute settlement panelists after the parties could not agree on panelists themselves. Perhaps indicating the country's growing familiarity with the cycles of international trade politics, China's public reaction to the proceeding has so far been relatively restrained. Nevertheless, the case has the potential to create friction that could affect companies.

The United States is also considering whether to confront China at the WTO over its protection of IPR. Washington would likely assert that the value thresholds China uses to determine whether to bring criminal charges against intellectual property infringers contravene the country's WTO requirement to prosecute all cases of intellectual property infringement of a "commercial scale." A WTO case on IPR would likely be controversial, since the results of findings against China could have a broad impact on PRC policies. US officials are in discussion with PRC counterparts to see if these issues can be resolved without resorting to WTO litigation.

Countervailing duties

The US Court of International Trade was expected to determine in late January whether DOC could proceed with a case that could lead it to impose countervailing duties on imports from China--a move that would counter a two-decade-long practice of not applying countervailing duty laws to nonmarket economies. Countervailing duties are a type of trade remedy that DOC imposes when it determines that a foreign producer receives a government subsidy that distorts market forces. Previously, DOC has held that it cannot apply countervailing duties to countries it deems nonmarket economies, such as China, since there are no market forces for a subsidy to distort. A federal court in 1986 upheld this policy. Lawmakers and small manufacturers have pressured DOC in recent years to revise that policy, at least in regard to China.

The case at hand stems from a petition filed by a US producer of coated free sheet paper asking DOC to impose countervailing duties on imports of that product from China and other countries. DOC agreed in November to investigate whether it should change its policy and apply countervailing duties to China.

The PRC government has challenged this case at the US Court of International Trade, arguing mainly that the 1986 court decision resulted in an interpretation of US law as prohibiting the application of countervailing duty laws to nonmarket economies. The US government countered that the 1986 court decision merely affirmed DOC's authority to choose not to apply countervailing duty laws to nonmarket economies, thereby leaving DOC with the option to revise the policy at its discretion.

Regardless of the outcome of the pending court case, it is possible that China could soon find itself subject to US countervailing duty laws. If the court sides with the US government, DOC is expected to revise its current policy. A PRC victory in the court, however, would likely lead to renewed congressional pressure for granting DOC the explicit authority to impose countervailing duties on imports from nonmarket economies--a proposal that has attracted a large number of supporters.

Export controls

Beijing has long bristled at the application of US controls on dual-use technology exports to China. A pending regulation from DOC would increase the scope of these controls and potentially complicate the bilateral commercial relationship. The China export control rule was published for comment in July 2006. The rule's two main parts expand the scope of US export controls for China but also establish a "Verified End-User" program that would streamline the export control process for sales to Chinese customers deemed trustworthy. While welcoming of the concept, many companies have expressed doubts about the effectiveness of the "Verified End-User" program as it has been proposed.

Also significant from a business perspective, however, is the rule's requirement that the PRC Ministry of Commerce (MOFCOM) issue end-user certificates for the Chinese customer of any item requiring a US export control license before DOC will issue that license. This requirement could create long delays for companies exporting to China, since the MOFCOM department that would be responsible for its implementation appears not to have a staff large enough to process these certificates in a timely manner. Moreover, Beijing's likely resentment at what it may view as an "unfunded mandate" could lead it to take actions that complicate the operations of US companies in other spheres of the commercial relationship. Finally, at a time when many foreign businesses are concerned about PRC government intervention to support domestic innovation, the requirement provides the government with a subtle tool to divert sales opportunities to domestic champions.

DOC is now reviewing public comments on the rule and may be making technical changes. In addition, the White House Office of Management and Budget (OMB) has designated the rule as a "significant regulatory action," subjecting it to further analysis to determine its effect on the US economy. Given the OMB review, the timing of the rule's final release is unclear.

Conclusion

The trade priorities of the new US Congress could result in significant pressures on the bilateral economic relationship, as US lawmakers attempt to address perceived inequities in US-China trade. In addition, the United States and China find themselves confronted with several points of commercial contention. With the establishment of the SED, however, the two countries have given themselves a strong mechanism with which to develop a mutually beneficial economic relationship in the long term. Policymakers from both countries will need to make full use of the SED, JCCT, and other mechanisms to demonstrate the continued efficacy of commercial engagement.