June 21, 1999

MEMORANDUM TO: OPINION LEADERS

FROM: GARY SCHMITT

SUBJECT: U.S.-China Policy

On June 3rd, President Clinton formally notified Congress that he was renewing “normal trade relations” -- formerly known as most-favored-nation status -- with China for another year. The renewal, unless disapproved by Congress within 60 days, will allow China to export goods to the U.S. at the same low tariffs accorded most countries. In Clinton’s message accompanying the notification to Congress, he stated that MFN’s renewal “is not a favor to China, but a means of opening and reforming China’s markets and holding China to the rules of the global trading system.” As the analysis below indicates, nothing could be further from the truth.

The Case for Revoking MFN this Year

Those who favor granting China most-favored-nation status like to argue that because China is the world's most populous nation, perhaps its second largest economy, and potentially East Asia's dominant power, it cannot be ignored or isolated. Yet it is precisely because China is all these things that the U.S. must take it and its evolution as a nation seriously. Although it is possible that China will some day become a responsible member of the international community, this is by no means inevitable. The only sure way that will happen is when the present Chinese regime is replaced by one governed by liberal democratic principles. Until then, America's policy goal should be to contain China's ambitions in the region by maintaining our system of democratic alliances, by keeping our military presence in East Asia robust, and by using whatever other levers we have to moderate its behavior.

MFN as Lever. Exports account for nearly 30% of China's Gross Domestic Product and the U.S. market now constitutes 35% of those exports. By contrast, China is the destination for less than 2% of our exports. There is no question that access to America's markets is far more critical to China than the reverse. As such, MFN is a significant benefit to China that the U.S. could use to insist on greater cooperation by China in any number of policy areas. With no ideology or open elections to provide legitimacy to their rule, China's leaders know that an expanding economy is important to justifying their continuing hold on power. With a slowing economy, declining foreign investment, and huge losses in state-owned enterprises, Chinese authorities cannot readily afford the substantial jolt to their economy – and, in turn, their rule – that would result from a revocation of MFN.

History provides clear evidence that China's leaders take the MFN lever seriously. Fearing the possible withdrawal of MFN-status in the aftermath of Tiananmen Square, China’s leaders were prepared to make a number of concessions to U.S. concerns. But, as Sinologist Andrew Nathan has noted, once Chinese authorities became convinced of "U.S. irresolution" – by fading anger in Congress and the Bush Administration's decision not to let the massacre interfere with relations – they came to the conclusion "that they no longer needed to take the issue seriously." The effectiveness of MFN as a lever vis-a-vis China has never really been in question. The real issue is Washington's will to use it.

Counterproductive? The U.S. business community argues that if the U.S. were to deny China MFN status, we would only be hurting ourselves, harming both American consumers by denying them access to cheap Chinese products and U.S. corporations who would lose access to Chinese markets in retaliation. These concerns presume that (a) goods produced by Chinese businesses cannot be acquired from other nations with comparable labor and production costs and (b) U.S. corporations are making significant profits from doing business in China. Neither assumption is correct.

In reality, U.S. access to China's markets is spotty at best and the rate of return on American investments in China is low in comparison with other nations in the region. Dire predictions of lost American jobs if China's MFN-status were revoked are exaggerated. With few exceptions, U.S. corporations do not sell much to China. More importantly, given China's dependence on the U.S. market for its exports, China cannot afford a tit-for-tat tariff war. No doubt there are enormous potential profits to be made in China. But these will remain only potential profits so as long as China maintains its present system of "crony capitalism" and its protectionist trade practices. If American businessmen had their own long-term interests in mind, they would see the threat of revoking MFN as a tool to open up China's markets and to establish a trading relationship far more equitable than the one that now exists.

Chinese Mercantilism. One thing we should be clear about, MFN -- unlike China’s accession to the WTO -- is not about free trade. The U.S. receives no reciprocal trade benefit from China for granting it MFN-status. In the last year, China exported $71 billion in goods to the United States, while U.S. companies sold China a little over $14 billion. As noted above, this latter figure amounts to less than 2% of America's total exports – a percentage that is virtually the same as in 1980 (or, for that matter, in 1900). In brief, trade with China is a one-way street: we lower barriers and they maintain high tariffs and an assortment of non-tariff barriers. The result is a $1 billion weekly trade deficit.

China's economic vision is fundamentally not free market-oriented, but mercantilist. The principal aim is not the expansion of individual prosperity and freedom but, instead, the accumulation of national power by means of promoting exports abroad, protectionism at home, and mandatory transfers of technology and know-how to Chinese enterprises as the price for limited access to China’s market. Such practices are not unusual for developing countries. But, as the Cox Commission has documented, they have allowed China to accumulate hundreds of billions of dollars in foreign hard currency with which it has been able to buy a whole array of advanced weaponry from Russia and others, and to acquire significant amounts of "dual-use" technologies to further its program of modernizing its armed forces. If China's trade practices are not all that unique, the strategic end to which they are aimed – China's dominance of East Asia – is.

Trade & Political Liberalization. When confronted with the disagreeable reality of the current state of trade and its impact on American security, supporters of MFN's renewal typically fall back on the argument that the price we are paying today is worth it in light of what will
eventually result from continued economic engagement with China. Bringing China into the
world economy will, it is claimed, generate a level of prosperity within China which, in turn, will create domestic pressures sufficient to force the country's political liberalization.

This is an interesting theory, but just a theory. The reality is that after two decades of economic engagement with China, there has been far less liberalization within China than U.S. business and administrations claimed would be the case. On the economic front, China's state-owned enterprises still control some 60% of China's assets; publicly-owned, shareholder-controlled companies make up less than 5% of its enterprises and foreign-owned firms even less; and its banks, all state-controlled, act as instruments to redistribute private savings to non-profitable, state-controlled enterprises. On the political front, the progress is even less. China's authoritarian rule has not been altered in any significant respect. And China's leaders remain adamantly opposed to a free press, independent political parties, democratic labor movements, and independent churches – the building blocks of a free, tolerant and democratic society.

China, today, is obviously not the China of Mao, and much of the progress that has been made there is due to China's partial turn from socialism and its adoption of elements of a market economy. However, for all the claims made China’s progress, it is still limited and, more importantly, capped by the fears of the Chinese Communist Party's leadership. Not wanting to repeat the self-induced collapse of the Party's rule in the Soviet Union, China's leaders have repeatedly demonstrated that, when confronted with the choice between pursuing reforms and maintaining their authority, they pick the latter.

MFN’s supporters of course tell themselves that none of this is ultimately relevant because economic engagement will transform China over time into a more benign regime. But they do so ignoring the unpleasant fact that, as U.S. economic engagement with China has increased over the past decade, internal reform within China has slowed and, significantly, as China's economic power has increased, its desire to replace the U.S. as Asia's leading power has grown.

Not This Year. The president is wrong: MFN is a “favor” the U.S. grants China. True, we normally extend MFN to most countries. But we do not normally extend it to authoritarian dictatorships which try to corrupt our political process, steal our nuclear secrets, aim to drive us out of a region of vital interest, and routinely violate agreements they have signed – including trade agreements. In view of all that has come to light this year, renewing MFN unconditionally smacks of appeasement, and it will be read as such by China's leaders. We should not be sending China this signal. It only reinforces the assessment of China’s leaders that their current behavior costs them little.

This is the right year to reestablish in the mind of the Chinese leadership that MFN’s renewal should not be taken for granted. The American economy is strong and unemployment is low; in contrast, the Chinese economy is slowing, and it is not prepared to see a substantial drop in exports to the United States. Whatever the short-term problems caused by MFN’s revocation, they are ones the U.S. can readily handle but China will be hard pressed to overcome.

Denying MFN is necessary if we want to revive MFN’s utility as a lever on Chinese behavior. Since President Clinton’s failure to follow through on his 1993 pledge not to renew MFN the following year if China had not met certain conditions, Beijing has had no reason to believe MFN will ever be used in this way. MFN can be a powerful foreign policy tool when it comes to China. But it can’t be if its renewal is routine and the threat of its revocation never more than a bluff.