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China-U.S. Trade Issues

Wayne M. Morrison
Foreign Affairs, Defense, and Trade Division

October 25, 1999

SUMMARY

U.S.-China economic relations have risen substantially over the past several years. Total U.S.-China trade rose from $17.8 billion in 1989 to $85.5 billion in 1998. Yet, U.S.-China economic ties have been strained by a number of issues. For example, U.S. policymakers have expressed concern over the sharp growth in the U.S. trade deficit with China, which surged from $6.2 billion in 1989 to nearly $57 billion in 1998; it could reach $66 billion in 1999. Many analysts believe that the burgeoning trade deficit is a reflection that Chinese markets are relatively closed to U.S. products.

The United States has pressed China to reduce trade barriers and improve protection of U.S. intellectual property rights (IPR). Under the threat of U.S. trade sanctions, China agreed to reduce trade barriers and improve IPR protection. Despite some reforms, market access and IPR piracy remain serious problems for U.S. firms in China.

China's trade policies (along with a number of political issues) have become a focal point in the annual congressional debate over renewing China's most-favored-nation (MFN) status (re-designated as "normal trade relations" (NTR) by law on July 22, 1998). Over the past several years, efforts have been made in Congress to terminate, or attach additional conditions to, China's MFN/NTR status, although none have succeeded. On July 27, 1999, the House, by a vote of 170 to 260, failed to pass H.J.Res. 57, a measure to terminate China's NTR status.

China has made its entry into the World Trade Organization (WTO) a top priority. The United States contends that China needs to substantially reform its trade regime before it is allowed to enter the WTO, while China has argued for more lenient accession terms.

Significant progress on a U.S.-China agreement on China's WTO accession was made during Chinese Premier Zhu Rongji's visit to the United States in April 1999, although a final agreement was not reached. China reportedly offered to make substantial cuts in tariffs, eliminate a wide variety of non-tariff barriers, and remove restrictions on the ability of U.S. firms to market goods and services in China. Separately, China agreed to immediately eliminate certain restrictions to U.S. wheat, citrus, and meat products.

U.S. officials acknowledged that China's April 1999 market access offers were significant, but indicated that a final trade agreement was not reached because a number of issues could not be resolved, such as China's market access for banking, securities, and audio visual services, and provisions governing rules for anti-dumping, import surges, and textile quotas. Following the accidental NATO bombing of the Chinese embassy in Belgrade on May 7, 1999, the Chinese government suspended the WTO talks. On September 11, the U.S.-China WTO talks were officially resumed.

China has indicated it would like to gain WTO membership before the November 1999 WTO Ministerial Meeting in Seattle, which will launch the next major world trade negotiations. Should China conclude trade agreements with the United States and other WTO members and gain entry into the WTO, Congress would likely consider legislation to extend permanent MFN/NTR treatment to China.

MOST RECENT DEVELOPMENTS

On September 11, 1999, the United States and China resumed negotiations on China's membership in the WTO during a meeting between President Clinton and Chinese President Jiang Zemin in Auckland, New Zealand during Asia-Pacific Economic Cooperation (APEC) Ministerial Meeting. China had suspended the talks in May 1999 after the accidental NATO bombing of the Chinese embassy in Belgrade.

On April 8, 1999, Chinese Premier Zhu Rongji met with President Clinton. While no final agreement on China's WTO accession was reached during Zhu's visit, U.S. negotiators indicated that significant progress was achieved in resolving key issues, such as barriers to agriculture, services, and various industrial products. On April 13, 1999, the United States and China agreed to "move intensively" on negotiations to resolve remaining issues in talks on China's WTO accession.

BACKGROUND AND ANALYSIS

U.S. Trade with China

U.S. trade with China rose rapidly after the two nations established diplomatic relations (January 1979), signed a bilateral trade agreement (July 1979), and provided mutual MFN benefits beginning in 1980. Total trade (exports plus imports) between the two nations rose from $4.8 billion in 1980 to $85.5 billion in 1998 — making China the 4th largest U.S. trading partner (see Table 1). Over the past 10 years, the U.S. trade deficit with China has grown significantly, due largely to a surge in U.S. imports of Chinese goods relative to U.S. exports to China. Between 1989 and 1998, U.S. exports to China increased by 147%, while U.S. imports from China surged by 493%. In 1989, the United States had a $6.2 billion trade deficit with China; in just 10 years it surged to $56.9 billion (1998), making China the second largest deficit trading partner of the United States, behind Japan. The U.S. trade deficit with China in 1999 could reach or exceed $66 billion.

Table 1. U.S. Merchandise Trade with China: 1988-1998
($ Billions)

Source: U.S. Department of Commerce.

*1999 estimate made by CRS.

U.S. Exports to China

U.S. exports to China in 1998 totaled $14.3 billion, accounting for 2.1% of total U.S. exports to the world, and making China the 13th largest market for U.S. exports. The top five U.S. exports to China in 1998 were (1) transport equipment (mainly aircraft and parts), (2) fertilizers, (3) electrical machinery, (4) office machines (i.e., computers), and (5) general industrial machinery and equipment. Together, these five commodities accounted for about half of total U.S. exports to China in 1998 (see Table 2).

Table 2. Top 5 U.S. Exports to China: 1994-1998
($Millions)

Commodities sorted by top 5 exports in 1998.

Source: U.S. Department of Commerce.

Many trade analysts argue that China could prove to be a significant market for U.S. exports in the future. China is one of the world's fastest growing economies and its efforts to reform and modernize its economy could result in a significant increase in demand for imports, especially if trade and investment barriers are reduced. The Chinese government has announced extensive plans to upgrade and modernize the economy. Infrastructure development, in particular, has been made a major priority, especially for goods and services relating to energy, transportation, and telecommunications. Such development could substantially increase Chinese demand for foreign imports, provided that trade and investment restrictions are eased.

Major Imports From China

China is a relatively large source of many U.S. imports, especially labor-intensive products. In 1998, imports from China accounted for 7.8% of total U.S. imports, making China the fourth largest supplier of U.S. imports. The level of U.S. imports from China nearly doubled between 1994 and 1998. The top five U.S. imports from China in 1998 were (1) miscellaneous manufactured articles (such as toys, games, etc.); (2) footwear ; (3) articles of clothing and apparel; (4) telecommunications equipment, sound recording, and reproducing equipment (such as telephone answering machines, radios, tape recorders and players, televisions, VCRs, etc.); and (5) office machines and automatic data processing machines (see Table 3). Together, imports of these five commodities accounted for nearly two-thirds of total U.S. imports from China in 1998.

Table 3. Top 5 U.S. Imports From China: 1994-1998
($ Millions)

Commodities sorted by top 5 imports in 1998.

Source: U.S. Department of Commerce.

The surge in U.S. imports of Chinese products over the past few years can be largely explained by two factors. First, China's production of low-cost, labor-intensive products (such as consumer goods) has increased sharply in recent years (due to China's comparative advantage in such sectors); U.S. demand for such products has steadily increased as well. Secondly, several foreign firms (especially those from Hong Kong and Taiwan) have shifted production of a wide variety of labor-intensive products (such as shoes, toys, and electronic products) into China to take advantage of China's relatively low-cost labor supply. As a result, many of the products that used to be produced in Taiwan and Hong Kong (a large share of which were exported to the United States) are now being produced by Hong Kong and Taiwanese firms in China, then exported.

China's Economy

China's economic reforms and open investment policies (which were begun in 1978) have contributed to a surge in economic growth. From 1979 to 1998, China's real GDP grew at an average annual rate of 9.8%, making it one of the world's fastest growing economies; real GDP growth in 1998 grew at 7.8% (although many analysts believe this figure may be too optimistic). Several economists have projected that, should China continue to implement economic reforms, annual real GDP growth could average over 7% over the next two decades. This means China could double the size of its economy every 10 years (see CRS Issue Brief 98014, China's Economic Conditions).

China has quickly become a major recipient of foreign direct investment (FDI), a key factor in its rapid economic growth. Much of that investment has gone into export-oriented production facilities. Annual utilized FDI in China grew from $636 million in 1983 to $45.6 billion in 1998. Cumulative foreign investment in China at the end of 1998 totaled $268.6 billion, making it the world's second largest destination of FDI after the United States. A significant share of FDI in China has come from overseas Chinese, especially Hong Kong and Taiwan, which account for over two-thirds of total FDI in China. The United States is the third largest investor in China. Major U.S. corporate investors in China include Motorola, Atlantic Richfield, Coca Cola, Amoco, Ford Motor, United Technologies, Pepsi Cola, Lucent Technologies, General Electric, and General Motors.

China has quickly become a major world trading power. Total Chinese trade (exports plus imports) rose from $21 billion in 1978 to an estimated $324 billion in 1998; over this period, China's ranking as a trading economy rose from 27th to 10th. The World Bank projects that China will become the second largest trading economy by the year 2020. Chinese exports in 1998 were $184 billion, while imports were $140 billion, producing a $44 billion trade surplus. The influx of foreign investment and the high growth of its exports have enabled China to accumulate a significant level of foreign exchange reserves — currently at about $145 billion.

Major U.S.-China Trade Issues

While China's economic reforms and rapid economic growth have expanded U.S.-China commercial relations in recent years, frictions have arisen over a wide variety of issues, including, China's failure to provide adequate protection of U.S. intellectual property rights (IPR), the widespread and pervasive use by China of trade and investment barriers, allegations that China has attempted to illegally obtain U.S. high technology, textile transshipments to the United States, the use of prison labor in the production of various exported products to the United States, and the conditions for China becoming a member of the World Trade Organization (WTO).

Violations of U.S. Intellectual Property Rights

Section 182 of the Trade Act of 1974 as amended (also known as Special 301"), requires the USTR to identify "priority foreign countries" that violate U.S. IPR, including patents, copyrights, trademarks, and trade secrets. It requires the USTR to initiate a Section 301 investigation of "priority foreign countries" that fail to provide adequate and effective protection of U.S. IPR or deny fair and equitable market access to U.S. firms that rely on IPR protection. The USTR is directed to seek negotiations with the priority nations to end such violations and, if necessary, impose trade sanctions.

In April 1991, China (along with India and Thailand) was named as a "priority foreign country" under Special 301. The USTR began a Section 301 investigation in May 1991, claiming China's laws failed to provide adequate protection of patents, copyrights, and trade secrets. In November 1991, the USTR threatened to impose $1.5 billion in trade sanctions if an IPR agreement was not reached by January 1992. Last-minute negotiations yielded an agreement on January 16, 1992. China promised to strengthen its patent, copyright, and trade secret laws, and to improve protection of U.S. intellectual property, especially computer software, sound recordings, chemicals, and pharmaceuticals.

In June 1994, the USTR again designated China as a Special 301 "priority foreign country," because it had failed to enforce recently enacted IPR laws. In particular, the USTR cited the establishment of several factories in China producing pirated compact and laser disks, as an example of China's "egregious" violation of U.S. IPR. In addition, the USTR stated that trade barriers had restricted access to China's market for U.S. movies, videos, and sound recordings, and that such restrictions encouraged piracy of such products in China. On February 4, 1995, the USTR announced that insufficient progress had been made in talks with Chinese officials and issued a list of Chinese products, with an estimated value of $1.1 billion, which would be subject to 100% import tariffs. However, a preliminary agreement was reached on February 26, 1995, and a formal agreement was signed on March 11, 1995. The new agreement pledged China to substantially beef up its IPR enforcement regime and to remove various import and investment barriers to IPR-related products. Specifically, China agreed to:

Take immediate steps to stem IPR piracy in China over the course of the next 3 months by taking action against large-scale producers and distributors of pirated materials, and prohibiting the export of pirated products.

Establish mechanisms to ensure long-term enforcement of IPR laws, such as banning the use of pirated materials by the Chinese government, establishing a coordinated IPR enforcement policy among each level of government, beefing up IPR enforcement agencies, creating an effective customs enforcement system, establishing a title verification system in China to ensure that U.S. audio visual works are protected against unauthorized use, reforming China's judicial system to ensure that U.S. firms can obtain access to effective judicial relief, establishing a system of maintaining statistics concerning China's enforcement efforts and meeting with U.S. officials on a regular basis to discuss those efforts, improving transparency in Chinese laws concerning IPR, and strictly enforcing IPR laws.

Provide greater market access to U.S. products by removing import quotas on U.S. audio visual products, allowing U.S. record companies to market their entire works in China (subject to Chinese censorship concerns), and allowing U.S. intellectual property-related industries to enter into joint production arrangements with Chinese firms in certain cities.

Several U.S. firms charged that IPR piracy in China worsened in 1995, despite the 1995 IPR agreement, and pressed the USTR to take tougher action against China. The International Intellectual Property Alliance (IIPA), an association of major U.S. copyright-based industries, estimated that IPR piracy by Chinese firms cost U.S. firms $2.3 billion in lost trade during 1995.

On April 30, 1996, the USTR again designated China as a Special 301 "priority foreign country" for not fully complying with the February 1995 IPR agreement. According to the USTR, while China had cracked down on piracy at the retail level (launching raids and destroying millions of pirated CDs and hundreds of thousands of pirated books, sound recordings, and computer software), it had failed to take effective action against an estimated 30 or so factories in China that were mass-producing and exporting pirated products. U.S. officials called on the Chinese government to close such factories, prosecute violators, and destroy equipment used in the production of pirated products. Further, the USTR stated that China failed to establish an effective border enforcement mechanism within its customs service to prevent the export of pirated products. Finally, The USTR indicated that China failed to provide sufficient market access to U.S. firms, due to high tariffs, quotas, and regulatory restrictions. Shortly after, the USTR indicated it would impose U.S. sanctions on $2 billion worth of Chinese products by June 17, 1996, unless China took more effective action to fully implement the IPR agreement. On June 17, 1996, Acting USTR Charlene Barshefsky announced that the United States was satisfied that China was taking steps to fulfill the 1995 IPR agreement. Barshefsky cited the Chinese government's recent closing of 15 plants producing illegal CDs and China's pledge to extend a period of focused enforcement of anti-piracy regulations against regions of particularly rampant piracy, such as Guangdong Province. The Chinese government also promised to improve border enforcement to halt exports of pirated products as well as illegal imports of presses used to manufacture CDs. Further, the Chinese government reaffirmed its pledge to open up its market to imports of IPR-related products. Finally, Chinese officials promised to improve monitoring and verification efforts to ensure that products made by Chinese CD plants and publishing houses are properly licensed.

The USTR has stated that China has made great strides in improving its IPR protection regime, noting that it has closed or fined 74 assembly operations for illegal production lines, seized millions of illegal audio-visual products, curtailed exports of pirated products, expanded training of judges and law enforcement officials on IPR protection, and has expanded legitimate licensing of film and music production in China. In April 1999, the USTR announced that the Chinese government had issued a new high-level directive to all Chinese government entities directing that they use only legitimate computer software, a move described by the USTR as a "milestone in China's efforts to increase intellectual property protection."

The USTR notes, however, that IPR piracy remains a serious problem in China, especially illegal reproduction of software, retail piracy, and trademark counterfeiting. In addition, while market access for IPR-related products has improved, high tariffs, quotas, and other barriers continue to hamper U.S. exports. The IIPA estimated that IPR piracy in China cost U.S. firms $2.6 billion in lost sales in 1998.

This document was produced by the Congressional Research Service. The Committee for the National Institute for the Environment (CNIE) has made these reports available to the public at large, but the CRS is not affiliated with the CNIE or the National Library for the Environment.

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