China's industrial policy and its impact on u. S. Companies, workers and the american economy

CHINA'S INDUSTRIAL POLICY AND ITS IMPACT ON U.S. COMPANIES, WORKERS AND THE AMERICAN ECONOMY

TUESDAY, MARCH 24, 2009

U.S.-CHINA ECONOMIC AND SECURITY REVIEW COMMISSION

The Commission met in Room 236, Russell Senate Office Building, Washington, DC at 9:02 a.m.,Chairman Carolyn Bartholomew, Vice Chairman Larry M. Wortzel, and Commissioners Patrick A. Mulloy, and Daniel M. Slane Hearing Cochairs), presiding.

OPENING STATEMENT OF CHAIRMAN CAROLYN BARTHOLOMEW

HEARING COCHAIR SLANE: Good morning, everyone. Welcome to today's hearing on "China's Industrial Policy and its Impact on U.S. Companies, Workers, and the American Economy."

Today's hearing will be cochaired by Commissioner Patrick Mulloy and me. Congress has given our Commission the responsibility to monitor and investigate the national security implications of bilateral trade and economic relations between the United States and China.

We fulfill our mandate by conducting hearings and undertaking related research, as well as sponsor independent research. We also travel to Asia and receive briefings from other U.S. government agencies and departments. We produce an annual report and provide recommendations to Congress for legislative and policy changes.

This is the third hearing from the 2009 reporting year, a year with a new administration in Washington. The new administration will have to deal with a lot of critical issues in 2009, along with the worst economic crisis the world has seen in the past 60 years.

I'd like to welcome our panelists and kindly ask that each speak for no more than seven minutes. This will allow the maximum time for questions and answers.

Now, I'd like to introduce Commissioner Mulloy.

OPENING STATEMENT OF COMMISSONER PATRICK A. MULLOY, HEARING COCHAIR

HEARING COCHAIR MULLOY: Thank you, Mr. Chairman.

I'm very pleased to have the opportunity to cochair today's important hearing. I also want to thank members of Congress who have been very supportive of the work of this Commission.

Oftentimes, we have members come and testify to start off the hearing, but there's so much going on in the Congress right now that it was difficult. But some of them sent over statements for inclusion in the record.

Let me read from Congressman Mike Michaud who is the head of the House Trade Working Group. He tells the Commission:

“Your work has been invaluable to those in Congress who are concerned about the economic, political and security implications of the U.S. relationship with the People's Republic of China.”

Senator Sherrod Brown will be coming by later this afternoon to make a statement.

Since taking power in October 1949, China's communist government has pursued an industrial policy. It wasn't very successful in the beginning because it was trying to do it within China. Deng Xiaoping in '78 decided that they needed to seek foreign technology, foreign investment, and foreign markets.

Back in 1981 when I first went to China, there were hardly any cars on the street. Today, China may make more automobiles than the United States of America. So something is working over there, and it's quite evident that this policy has implications for the United States of America.

So, today, we want to explore the overall nature of China's industrial policy and we want to look at the role that foreign direct investment and China's use of incentives to attract foreign investment have played in building their strategic and pillar industries.

We want to thank our witnesses who have all submitted very good testimony. The commissioners have had a chance to read it, and we'll take it into account both in today's hearing and then when we write our annual report for the Congress. So we appreciate your being here. Now let me turn it back to my cochairman, Commissioner Slane.

OPENING STATEMENT OF COMMISSIONER DANIEL M. SLANE

HEARING COCHAIR

HEARING COCHAIR SLANE: Thanks. Thank you, everyone, for coming, and we want to express our appreciation to the Senate Armed Services Committee for providing today's hearing venue, and a special thanks to our staff for the great job they did in putting this hearing together.

A transcript of today's hearing will be published on our Web site, which is uscc.gov, and today's written testimony will be posted on the Web site as well, and by the end of November, our 2009 Annual Report will appear on the Web site and in the form of a bound paper copy. Today's hearing will provide a wealth of information for that annual report.

For those of you who will be with us the entire day, I'll note that there will be a break for lunch at 1:00 p.m., and we will resume promptly at two. There's a snack bar and carry-out in the basement of the Russell Senate Office Building. There's also a cafeteria in the basement of the Dirksen Building that is connected to the Russell Building by a long hallway, and I have to warn everybody that the microphones are always on so please don't embarrass yourself.

Now let me introduce our first panel. Our first panel for today is going to address, among other things, the evolution of industrial policy in China. In particular, we're interested in hearing about China's pillar and strategic industries in general.

Alan Wolff leads Dewey & LeBoeuf's International Trade Practice Group which represents clients involved in some of the most important trade issues of our day.

Mr. Wolff has a long and distinguished career in international trade that includes over 25 years as a Managing Partner with Dewey Ballantine. Before that, Mr. Wolff worked as General Counsel and Deputy U.S. Trade Representative for the Carter administration.

George Haley is a Professor of Industrial Marketing at the University of New Haven where he teaches in the Graduate and Executive Programs.

Dr. Haley is also the founding Director of the Center for International Industry Competitiveness. Dr. Haley is an expert on emerging and industrial markets including the historical, cultural and legal environments in which the Chinese business strategy is formulated.

Clyde Prestowitz is founder and President of the Economic Strategy Institute which deals with international trade policy, economic competitiveness, and the effects of globalization.

Prior to founding ESI, Mr. Prestowitz served as a Counselor to the Secretary of Commerce in the Reagan administration. Mr. Prestowitz regularly writes for leading publications, including the New York Times, the Washington Post, Fortune and Foreign Affairs, and wrote a great book on China.

Thank you.

We'll start with Mr. Wolff.

PANEL I: OVERVIEW OF CHINA’S PILLAR AND STRATEGIC INDUSTRIES

STATEMENT OF MR. ALAN WM. WOLFF

PARTNER, DEWEY & LEBOEUF LLP

WASHINGTON, DC

MR. WOLFF: Good morning and thank you to Commissioners Slane and Mulloy and the other commissioners this morning.

I appreciate the opportunity to be before you this morning. There is too little focus on industrial policy in this country, the industrial policies of other countries. We were not very well focused on what the Europeans were doing with Airbus. We as a country were not very focused on what the Japanese were doing with electronics and a number of other industries, and that was to our cost, I think, as a country and to our industrial base.

I think that the work you are doing is extraordinarily important. This subject is important for China as well because there is a misallocation of resources that takes place with industrial policy that the Chinese should be focused on as well.

There is no definition of “pillar industries” as a generic term in that each Chinese municipality, every province, has a series of industries that it treats as pillar industries. I think that looking at autos, steel, and the industries that are cited in the Medium and Long-Term Science and Technology Plan, the 15-year plan from the Ministry of Science and Technology in China, that would be a pretty good list. And the specific projects and sectors are listed in my testimony.

There are very elaborate papers that are being issued by the Ministry of Science and Technology and other Chinese ministries, which in effect create what the Chinese government sees as the necessary support for their pillar industries, their strategic industries.

For my testimony, I've misappropriated Deng Xiaoping's saying that, "I don't care if it's a white cat or a black cat; it's a good cat as long as it catches mice."

In fact, I'm using it in the reverse of the way he was using it because "black" to him was capitalism, and to me "black" is what might be WTO inconsistent or cause a problem for China's trading partners.

So there is a duality to Chinese policies. They fall into two categories:

There are policies that we have to match—namely the emphasis on science, technology, engineering, math education. Clearly, that is in the President's Budget, and it is in the stimulus package, and it is something that you can't fault.

Science and technology parks. The Chinese have a vast number of these. They are very large. If you look at what Research Triangle did for North Carolina, which was a phenomenal success--for North Carolina was 49th in the country in terms of per capita GDP, and is now in the upper ranks as a result of Research Triangle Park, in large part, and the resulting attraction of industry.

My first trip to China included a lecture I gave at Pudong University in 1988. If you look across the river from Shanghai, Pudong was just an empty field. It is no longer empty.

Of the black policies, of the three areas which I chose as examples--one is product standards using as an illustrative practice encryption. It is going to be a major cause of friction between the United States and Japan and Europe, on the one hand, and China on the other. The use of standards is going to be very trade-distorting. We already experienced the WAPI, Wireless LAN, example as a problem, but we are going to have very serious problems going forward.

China has declared that its MLPS, Multi-Level Protection System, in which it grades the level of encryption that is necessary, making banking and finance a level three, that requires Chinese indigenous technology, indigenous patents.

If we did that the same thing, China wouldn't be trading with the United States to any great extent. If we just said, well, we want everything coming into this country in a whole variety of areas to have American technology and American patents, then if we reciprocated what China is saying that it will do--the regulations are not fully in effect yet--China would have major trade problems with the United States.

I also have looked at information technology equipment and looked at the means that China uses to exclude foreign competitors from its market, and it's not just the use of subsidies. It is an industrial organization, not quite like keiretsu, but there are relationships which provide a very serious protection. So the problem is a combination of subsidies as well as protection.

A third example I gave was oil country tubular goods. One could have chosen something else, but we at our firm studied this product sector in some detail. It was a primary industry of concern to China. It got enormous policy support--many billions of dollars of subsidy and protection. And the result is that the United States industry will, in fact, suffer injury at some point if it hasn't already.

And it includes, as we saw in Europe, debt-to-equity swaps, not perhaps dissimilar from what we're doing with AIG, except for one thing, and that is our intent is not to have AIG emerge dominant in the world as the leading financial services provider, whereas, what the Chinese are doing, as the Europeans did in past times, is try to have their industries emerge as dominant suppliers.

In terms of the implications of China's policies, one study that we did recently indicates that the results are very mixed, that American semiconductor producers, for example, are not increasing the location of their R&D location to China very much because of concerns over intellectual property.

While the semiconductor executives responding to our survey didn't say this, I would suggest that it was not just the lack of intellectual property protection, it was government policy that was a matter of concern. So China is having, I would say, mixed results.

In sum, I think our government has to know more. You are performing an extraordinarily important role in that process, but I think the Commerce Department and other agencies in the U.S. government should spend a good deal more attention on what's going on abroad that reshapes our economy.

Thank you.

[The statement follows:]

Prepared Statement of Mr. Alan Wm. Wolff

Partner, Dewey & Leboeuf LLP

Washington, DC

[This testimony is not intended to represent the views of Dewey & LeBoeuf or its clients.]

The invitation to this hearing listed ten specific questions which I will attempt to address in the context of the work that I and our firm has done to date:

There is no single, permanent definition in China of a "pillar industry." Beijing municipal authorities announced in 2008 that for it tourism would be a pillar industry in the post-Olympics period. The same for Xinjiang. Coal mining is Shanxi's pillar industry. Automobile manufacturing is said to be the pillar industry for the Chinese economy. Also biotechnology. For Chongqing, information technology. For Nanchang, the semiconductor industry. But also pillar industries for all or part of China are variously: petrochemicals, non-ferrous metals, insurance, telecommunications, banking, wholesale, and utilities. So to some extent, being a "pillar industry" is synonymous with being "important enough to be supported by central, provincial or local government policy".

As the focus at this Hearing is the impact on United States industries and workforce of China's supportive policies, a more relevant class of China's pillar industries for today's discussion are those that are now or will in the future offer competition to American industries. Aside from automobiles, which are likely to arrive on these shores from China in the not terribly distant future in large numbers as they did from Japan and Korea, I would turn to the Medium and Long Term Science and Technology Plan of the Ministry of Science and Technology (MOST) for guidance as to areas of primary interest. A key aspect of the Medium and Long Term S & T Plan it to make intensive investments in “strategic products".

Under China's S&T Plan, key projects cover a number of priority sectors:

    • core electronic components,

    • high-end general chips and basic software;

    • the technology for manufacturing extremely large integrated circuits;

    • new-generation broadband wireless mobile telecommunications;

    • high-end numerical controlled machine tools and basic manufacturing technology;

    • development of large oil and gas fields;

    • large nuclear power plants with advanced pressurized water reactor, high-temperature gas-cooled reactors;

    • control and treatment of pollution in water bodies;

    • nurturing new, genetically modified biological species;

    • development of important new drugs;

    • control and treatment of major contagious diseases such as AIDS and viral hepatitis;

    • large aircraft; high-resolution earth observing system;

    • manned space flights; and

    • lunar exploration projects.

Detailed, elaborate papers address the policies which are believed to be necessary to achieve the project goals. Over ninety-nine of these papers have been planned, called “Guiding Opinions”. A sampling indicates the breadth of their coverage:

  • Accelerating Creation of Independent, ‘Well-known’ Chinese Brands;

  • Supporting Technology Innovation of Small and Medium-sized Enterprises;

  • Issuance of Corporate Bonds for Qualified High-Tech Enterprises;

  • Regulation on Management of Start-up Investment Funds and Debt Financing ability of Start-ups;

  • Suggestions on Establishing and Improving Regional Intellectual Property;

  • Standardizing Foreign Acquisition of Key Chinese Enterprises in the Equipment Manufacturing Industry;

  • Building Research-orientated Universities;

  • Promoting the Development of State Supported High and New Technology Industry Development Zones;

  • Establishing Guidelines and Funding for Venture Capital Investment;

  • Creating Tax Policies Supporting the Development of Start-Ups; and

  • Establishing ‘Green Channels’ for High-level Talents Who Have Studied Abroad to Return to China.

The comprehensiveness of these papers is remarkable by any measure. They are designed to at least equal the results achieved by more evolved market economies that have had a head start of decades and in some cases of over a century. This requires China to acquire a financial, educational and legal infrastructure in record time to support an economy whose growth is to be based on innovation.

How much intervention and of what kind?

I don't care if it's a white cat or a black cat.

It's a good cat so long as it catches mice.

Deng Xiaoping

A key question everywhere is what kind of state interventions best serve national interests and are deemed constructive by a country's trading partners. Globalization has put all nations into one world economy with fewer national barriers separating one trading partner from another. The origins of the current economic crisis stem in part from an excessive rate of savings in some countries, most prominently China, and in too high a propensity to borrow (and invest poorly) among other countries, most prominently, the United States. Global imbalances may have their roots in relative rates of savings, but combined with industrial policies, they have a differential impact on various sectors of each economy. Promotion of a given sector by one country will not in fact result in a win-win result as seen from the vantage point of those companies located in another country who are trying to compete in that same sector. (Ask Boeing about Airbus.)

Chinese government policies have a dual nature -- that is that there are promotional policies which are broadly considered to be acceptable by China's trading partners (white cat analogues) and other Chinese policies that are a matter of real concern (black cat analogues). About this latter category, a key question is whether the policies which harm others are in fact good for China. Another question is whether each black cat measure is consistent with China’s WTO commitments, including those contained in its Protocol of Accession. In the category of black measures fall inadequate protection of intellectual property, national standards that act to insulate the Chinese market from the rest of the world, potential use of competition policy as an industrial policy tool, discriminatory government procurement, and subsidization that excessively distorts trade and investment patterns.

Taking the most recent past first, it is worth focusing on the much-praised series of Chinese stimulus packages. China has put into place a series of measures that appears to be intended to preserve, as governments wish to do, maximum benefits at home. China’s Ministry of Industry and Information Technology (MIIT) currently plans to assist its electronics and information industries: electronics, telecommunications and Internet; via a number of key projects: integrated circuit, flat panel display, TD-SCDMA, digital TV, computer and next generation Internet, software and information service. According to reports, the measures to be used include direct state financial support, tax breaks, and measures to expand domestic demand. The Shanghai IC Industry Association is seeking additional investment from the government in IC companies. For the mobile phone and household electrical appliance industries, it is expected that there will be lower tax rates, additional subsidies, cash grants and increased state-bank lending.

Foreign industry concerns center on aspects of China's stimulus package that go beyond limited subsidies to encompass measures which limit competition: by emphasizing procurement by government and state-owned enterprises of products incorporating indigenous Chinese intellectual property, requirements for government purchases of software that is only interoperablewith Chinese software, further emphasis on use and development of indigenous standards and use of exclusive information security standards. None of these concerns are new.

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