USTR - 1996 National Trade Estimate-People's Republic of China
Office of the United States Trade Representative

 

1996 National Trade Estimate-People's Republic of China

In 1995, the U.S. trade deficit with China was $33.8 billion, $4.3 billion greater than in 1994. U.S. merchandise exports to China for 1995 were $11.7 billion, up $2.5 billion or more than 26 percent from 1994. China was the United States' thirteenth largest export market in 1995. U.S. imports from China in 1995 amounted to $45.6 billion, up 17 percent from 1994.

The stock of U.S. direct investment in China was $1.7 billion at the end of 1994, or about 82 percent higher than at the end of 1993. U.S. direct investment in China is concentrated largely in manufacturing, petroleum, and wholesale.

OVERVIEW

Over the past year, China saw the dividends of its austerity program -- pursued since 1993 -- as inflation came under control and real GDP growth showed a corresponding gradual slowing. For example, in 1995 retail price inflation dropped sharply, reaching a low of 9 percent in November, after having peaked at over 25 percent in October 1994. Real GDP growth slowed to just over 10 percent in 1995, down from almost 12 percent in 1994 and over 13 percent in 1992 and 1993.

One of Beijing's main tools to ease inflation was stronger restrictions on food prices, including periodic price inspections and government management of supply by selling stockpiled grain. Food price increases -- a major source of inflation in 1994 -- also slowed because central authorities stepped up the pressure on localities to boost grain supplies, approved sharp increases in grain imports, and restricted exports.

The other main lever China used to cool the economy was stronger controls on credit and investment. State- sector investment during the first three quarters of 1995 was 17.6 percent over that in the same time in 1994, compared with 34 percent nominal growth in 1994, and 58 percent growth in 1993. Tighter credit policies were reflected in the slower growth of the money supply as M1-currency and checking deposits -- grew at an 18 percent rate for the first three quarters compared to 27 percent in 1994.

Tighter restrictions on credit, however, increased pressures on poorly performing state enterprises. The general slowdown in the economy was accompanied by sharp increases in debts between enterprises, layoffs, inventories, and nonperforming loans. Such costs raised pressures on central policymakers for a loosening of credit policy. In response, Beijing slightly relaxed credit to larger firms for working capital in the third quarter of 1994, and new enterprise reform plans include provisions for selected large state firms to receive preferential access to bank loans. Central leaders, nevertheless, must balance the risk that easing these controls could fuel new price hikes against the prospect that continued anti-inflation policies could trigger labor disturbances if more enterprises fail to meet payrolls while new job opportunities shrink. Despite continued pressures for looser credit, central bankers and monetary policymakers have repeatedly said they will continue "relatively" tight monetary policies in 1996.

Central leaders continue to balance the costs and benefits of tough reform steps. For example, leadership concerns over labor disturbances have tempered progress on some key reforms. Chinese media in late 1994 began touting the state-owned enterprise sector as the focus of structural reforms in 1995, for example, but authorities have moved gingerly with potentially disruptive steps, such as bankruptcy and privatization. The regime's reluctance to press ahead with tough reform steps, such as bankruptcies among deficit-ridden state enterprises, is increasing the burden of state-sector debts on the state banking system and is therefore hindering financial sector reforms. Central leaders also face obstacles in completing other reforms initiated during the past two years.

China's growing focus on certain "pillar industries" -- including machinery, electronics, and autos, among others -- is becoming increasingly evident in the composition of China's trade. Manufactured goods dominated China's exports for 1995 -- which shifted away from traditional labor-intensive products -- as exports of electrical and machinery products exceeded textiles for the first time. Imports of manufactured goods grew sluggishly for 1995, while imports of primary products -- particularly agricultural products -- soared.

China's growing economic strength, coupled with its focus on boosting competitiveness in certain export- oriented industries, requires continued vigilance of the Administration to ensure China's policies and practices are consistent with existing agreements and are in line with international trading standards. During 1995, the United States and China engaged intensively in bilateral consultations on issues including implementation of the 1992 Market Access and the 1995 IPR Enforcement Agreements, market access for services, textiles, and WTO accession.

Recent Trade Agreements

Since 1992, the United States has successfully negotiated four landmark trade agreements with China. The most recent such agreement was reached on the enforcement of IPR, on February 26, 1995. In a 1992 Memorandum of Understanding (MOU), China committed to strengthening IPR protection and toughening its IPR legal regime. On October 10, 1992, the United States and China signed a MOU on market access that commits China to significant liberalization of key aspects of its import administration, including reduction of trade barriers and gradual opening of its market to U.S. exports. This Agreement resolved a self-initiated 301 investigation that started in October 10, 1991. The investigation examined four broad areas: the absence of transparency; import licensing requirements; import quotas, restrictions, and controls; and standards and certification requirements. In January, 1994, the United States and China renewed the bilateral textile agreement, mandating slower growth in Chinese exports of textiles and apparel to the United States and new restrictions on exports of silk apparel.

IMPORT POLICIES

China committed in the 1992 bilateral Market Access Memorandum of Understanding (MOU) to reform significant parts of its import regime, especially its use of multiple, overlapping non-tariff barriers that restrict imports. Despite a number of steps taken pursuant to its commitments in the MOU, including removing non-tariff measures (NTMs) such as quotas and licensing requirements, China still maintains a large number of non-tariff administrative controls to implement its trade and industrial policies. In addition to such quotas and licensing requirements, China also restricts the types and numbers of entities within China which have the legal right to engage in international trade. Foreign exchange balancing regulations could also further restrict imports even for firms that possess the right to import. Finally, despite recent moves to lower tariffs, China's tariffs, in many cases, remain prohibitively high.

Non-Tariff Measures

Measures that can act as non-tariff barriers are administered at national and subnational levels by the State Economic and Trade Commission (SETC), the State Planning Commission (SPC), and the Ministry of Foreign Trade and Economic Cooperation (MOFTEC). These non-tariff barriers include import licenses, import quotas, and other import controls. The levels of imports permitted under these measures are the result of complex negotiations between the Central Government and Chinese ministries, state corporations, and trading companies.

Central Government agencies determine the levels of import quotas through data collection and negotiating sessions, usually late each year. These agencies -- including the SPC, SETC, and MOFTEC -- determine the projected demand for each product subject to import restrictions, which generally include quantitative restrictions. Officials at central and local levels evaluate the need for particular products for individual projects or quantitative restrictions for the products. Once "demand" is determined, Central Government agencies allocate quotas that are eventually distributed nationwide to end-users and administered by local branches of the Central Government agencies concerned. China has yet to publish updated information on products subject to quantitative restriction by tariff line and by quantity and value, despite a commitment in the 1992 MOU to do so.

MOFTEC uses import licenses to exercise an additional nationwide system of control over some imports. Many products are subject both to quotas or restrictions and also to import licensing requirements. For these products, after permission has been granted by other designated agencies for its importation, MOFTEC must decide whether to issue a license. MOFTEC officials claim that import licenses are issued automatically once other agencies have approved an import.

A myriad of import licensing requirements has acted as an effective import barrier to the Chinese market. China's licensing system has encompassed 53 large product categories of consumer goods, raw materials, and some production equipment, and covers approximately 50 percent of total imports by value. Despite steps China has taken under the bilateral MOU to eliminate licensing requirements, in early 1994 China issued two catalogues -- one for electrical and machinery products, and another for general commodities – listing products that are now subject to "automatic registration requirements" and quota administration. The implementation of this registration requirement appears to pose a new de facto licensing requirement for products covered in the catalogue. Several hundred products which had license or quota requirements removed pursuant to the MOU are now subject to this registration requirement.

In many cases, the ministry that oversees the manufacture of a product has a role in administering import regulations for the same product. These parent ministries are not anxious to diminish protection of the products that sustain the budgets of the agency or its affiliated manufacturing companies. For example, China's "Electrical and Machinery Product Import Control Measures", issued in May 1995, require that electromechanical import control offices be established in those enterprises and institutions that have administrative responsibilities for an industrial sector, posing possible conflicts of interest.

Although China's import approval process remains complex, China is taking some important steps to streamline the process and to reduce gradually the range of imports subject to non-tariff barriers. For example, Central Government agencies have published many -- though not all -- of their import administration laws and regulations, making China's trade regime more transparent. China has also taken steps to implement its commitment in the 1992 bilateral market access MOU to eliminate specified import restrictions no later than the end of 1997. The third, and most recent, round of NTM eliminations took effect on December 31, 1995, covering 176 of the items specified in the market access MOU for elimination in 1995. These included a number of alcoholic spirits, organic chemicals, photographic goods, certain air conditioning machines, electronic integrated circuits and microassemblies, and other items. However, China still maintains NTMs on some products that were scheduled for removal in 1994 under the MOU. The MOU specifies further eliminations of non-tariff import barriers that China has agreed to undertake prior to the end of 1996 and 1997.

Comments from U.S. exporters and investors have led to concerns that new alternative measures and some aspects of China's new industrial policies may be undercutting the market access gains that had been anticipated from elimination of the earlier import licenses and quotas. These include the new "automatic" registration requirement, electromechanical product import control measures, new regulations on the administration of medical equipment, proposed guidelines for the electronics sector, and camera import control measures, among others. In 1995, the United States Trade Representative's Office continued market access discussions to reduce non-tariff barriers further with China, both bilaterally and in the context of multilateral discussions on China's accession to the World Trade Organization (WTO). Such new regulations are under discussion with the Chinese in these contexts.

Trading Rights and Other Restrictions

Chinese restrictions on the types and numbers of entities within China which may receive the legal right to engage in international trade further constrain possible sales to China. Only those firms with import trading rights may bring goods into China; foreign-invested firms in China often have the right only to import materials for their own manufacturing. These same firms are often subject to export performance requirements.

As a result of non-tariff measures and other restrictions, China's real demand for imported products greatly exceeds the supply made available through the official system. For example, the U.S. spirits industry estimates that only 10 percent or less of imported distilled spirits enter the Chinese market through official channels. Thus, a large gray market for spirits has grown up around the official system. This has resulted in revenue losses for China, threats to the reputation of and official channel sales by foreign spirits manufacturers, and danger to Chinese consumers who, like the foreign spirits manufacturers, cannot be sure that the product sold in China in their bottles is legitimate.

Tariffs and Taxes

China has used prohibitively high tariffs, in combination with import restrictions and foreign exchange controls, to protect its domestic industry and restrict imports -- contributing to inefficiencies in China's economy, and posing a major barrier to U.S. commercial opportunities. Nominal MFN tariffs facing goods entering China in 1995 ranged as high as 150 percent, while the average nominal import tariff exceeded 35 percent. Despite tariff reductions in some areas, U.S. industry has expressed concern that tariff rates for sectors in which China is seeking to build its international competitiveness, such as chemicals, remain extremely high.

High nominal rates and unpredictable application of tariff rates create difficulties for companies trying to export to, or import into, the Chinese market. Tariffs may vary for the same product, depending on whether the product is eligible for an exemption from the published tariff. High-technology items whose purchase is incorporated into state or sector plans, for instance, have been imported at tariff rates significantly lower than those published. In addition, import tariffs have sometimes been reduced or even not applied, through temporary tariff rates published by China's Customs General Administration or through informal means. A senior China Customs official speaking early in 1996 was quoted in the Chinese media as saying that the nominal tariff collected was less than 5 percent. Nonetheless, China's high nominal tariff rates and non-tariff restrictions on imports have contributed to significant smuggling into China for many types of goods. Examples appearing in 1995 press reports include personal computers, spirits, agricultural products, petroleum products, steel products, and automobiles.

China has taken steps to reduce tariffs pursuant to its bilateral commitments, and in an effort to boost its WTO accession bid. In November 1995, China's President Jiang Zemin announced that China would make tariff reductions on more than 4000 tariff line items in 1996. China's stated goal is to bring its average nominal tariff down to 23 percent in 1996, and to make further reductions to reduce its average nominal tariff down to about 15 percent in 1997. In late December 1995, MOFTEC began publishing, in installment fashion in MOFTEC's newspapers, the tariff deductions by individual tariff line product that will enter into force on April 1, 1996.<1>

In addition to import tariffs, imports may also be subject to value-added and other taxes. Such taxes are to be charged on both imported goods and domestic products, but application has not been uniform, and these taxes may be subject to negotiation. China has used the combination of tariffs and other taxes to clamp down on imports that officials viewed as threatening domestic industries.

U.S. and other foreign businesses selling goods into China often complain about China's customs valuation practices. Different ports of entry may charge different duty rates on the same products. Because there is flexibility at the local level in deciding whether to charge the official rate, actual customs duties are often the result of negotiation between businesspeople and Chinese customs officers. Allegations of corruption also often result.

In a move that could raise major project costs in China by 20 percent or more despite nominal tariff reductions underway, China is phasing out over a two-year period tariff exemptions for capital equipment imported by foreign investors in China. In early 1996, Chinese officials were still finalizing and clarifying the details and criteria under which firms, products, and projects will be eligible for tariff exemptions of up to another two years. The future tariff treatment of goods brought in for projects financed by international financial institutions is also being clarified in early 1996.

Creating uncertainties for traders and investors alike are China's slow pace of publication of the April 1 tariff reductions; reclassification of tariff nomenclature; uncertainties about the phase-out of tariff waivers for capital goods brought in by foreign investors; and other anomalies. The likelihood that lower temporary import duties instituted in 1995 on 246 product categories or tariff line items will be continued after April 1, and the categories of goods covered by any temporarily lowered import duties after April 1, are also not known. Some tariff lines that appear in the 1995 temporary import duties schedule have not appeared in the installments of post-April 1 duty rates as serially published. Nonetheless, the 1996 reductions and second phase reductions planned for 1997 should improve U.S. export performance to China.

Import Substitution

Import substitution has been a longstanding Chinese trade policy. Nonetheless, upon signature of the market access MOU in 1992, China confirmed that it had eliminated all import substitution regulations, guidance and policies and that it would not subject any products to import substitution measures in the future. This constitutes a commitment that a Chinese government agency will no longer deny permission to import a foreign product because a domestic alternative exists. Despite this commitment, in 1994 China announced an automotive industrial policy that included clear import substitution requirements. This policy, designed to foster development of a modern automobile industry in China, explicitly calls for production of domestic automobiles and automobile parts as substitutes for imports, and establishes local content requirements, which would force the use of domestic products, whether comparable or not in quality or price. In mid-1994, when the automotive industrial sector policy was announced, Chinese officials stated that industrial policies for other sectors would follow. China's Ministry of Machinery Industry and Ministry of Electronics industry are reportedly preparing drafts of possible industrial policies for their sectors, which U.S. businesses are concerned will contain similar import substitution measures.

U.S. labor interests are also expressing concern that in other sectors -- such as aircraft -- China has informal industrial targeting and forced technology transfer requirements.

STANDARDS, TESTING, LABELING AND CERTIFICATION

China continues to use standards and certification practices which the United States and other trading partners regard as barriers to trade. By and large, China does not accept U.S. certification of product quality, adding expense and uncertainty for U.S. exporters. For manufactured goods, China requires that a quality license be issued before the goods can be imported into China. Obtaining such licenses can be a time-consuming and expensive process. China often requires testing and certifications of foreign products to ensure compliance with standards and specifications unknown and unavailable to the exporter.

The 1992 Market Access MOU requires that China apply the same standards and testing requirements to non-agricultural products, whether foreign or domestic. Efforts by U.S. companies to export to China, however, are often hampered by standards and testing requirements that demand higher quality standards than those that are applied to China's domestic products. For some types of product inspections, China does not use the same inspection agency for domestic and imported goods. For example, the Chinese Government continues to require foreign pesticide producers to submit to costly testing and registration procedures, but it does not apply these requirements to domestic producers. U.S. companies report that complying with these regulations costs more than $5 million per agricultural chemical. These practices delay or discourage the entrance of U.S. products into China and increase costs for U.S. businesses.

China also committed in the 1992 MOU to base its agricultural import standards on "sound science". China's phytosanitary and veterinary import quarantine standards, however, are often overly strict, unevenly applied, and not backed up by modern laboratory techniques. An example is China's use of Mediterranean fruit fly occurrences in urban Los Angeles as a reason to ban the entry of all citrus fruit from the United States. Since 1992, China has made some progress on agricultural sanitary and phytosanitary issues, signing bilateral protocols for several agricultural items including live horses (protocol signed in September 1994); apples from Washington, Oregon and Idaho (April 1995); and ostriches, bovine embryos, swine and cattle (June 1995). However, China's sanitary and phytosanitary measures still prohibit imports of citrus, plums, grapes, tobacco, and Pacific Northwest (PNW) wheat.

China's unscientific restrictions on PNW wheat and citrus is of particular concern to U.S. industries, and the U.S. has continued to address these issues at senior levels, including at the New York summit meeting hosted by President Clinton in October 1995. Discussions aimed at resolving the other outstanding agricultural issues has also been ongoing. Technical experts from the United States and China met in Shanghai in January 1996 for phytosanitary discussions that covered California plums, grapes, cherries, apples, and tobacco. In addition, China has been slow to address phytosanitary issues relating to citrus, particularly from California. China sent a technical team to inspect U.S. citrus-growing regions -- including California, Florida, Texas and Arizona -- late in 1995. In early 1996, the United States still awaits China's pest risk analysis from the technical team's inspection of U.S. citrus-growing regions.

GOVERNMENT PROCUREMENT

China's government purchasing actions and decisions are subject to China's general laws, regulations and directives. Despite its commitment under the 1992 market access MOU to publish all laws and regulations affecting imports and exports, some regulations and a large number of directives have traditionally been unpublished ("for internal use"), and there is no published, publicly available national procurement code in China. Only one tendering organization, the National Tendering Center for Machinery and Electrical Equipment, has published a tendering guide, which is brief and vague. If the Chinese government maintains any laws, regulations and policies on the conduct, evaluation and award of government procurement procedures, they remain restricted for "internal use" and inaccessible to foreigners, including government officials and business representatives.

Based upon experiences of U.S. firms, government approval, at some level, is required for most projects in China for which imports are required. Projects in certain fields require approvals from several different organizations and from different levels, depending on the value of the project or purchase. Projects of government-owned enterprises or projects requiring government funds valued at less than $10 million for inland provinces (or $30 million for coastal provinces and major jurisdictions including but not limited to Beijing, Shanghai, Tianjin, and Guangdong) must receive approval by their own departments or planning commissions at the provincial level. Projects over $30 million require approval by the ministries in charge of the industry concerned as well as State Planning Commission examination and approval. They also need final approval by the State Council. China has moved toward an interbank market for foreign exchange and partial current account convertibility, but the extent to which the current changes will eliminate the need for approval to use foreign exchange remains unclear.

For projects using foreign loans provided by international organizations such as the World Bank, procurement complies with the standards set by the donor organization. Such procurement is overseen by either one of a handful of tendering companies that are subsidiaries of state-owned trading companies or the State Council's National Tendering Center. Procurements made with international financing requiring competitive bidding, regardless of the level of government, must be tendered. Other procurements need not be tendered but are encouraged to do so. Even if the bidding guidelines set up by the national tendering center must be followed for tenders that it conducts, the guidelines are vague enough to allow significant flexibility. For procurements that are not required to meet World Bank standards, tendering procedures are optional and, to the best of our knowledge, seldom used. Influenced by contacts with the World Bank and other organizations, the State Planning Commission is understood to be examining the possibility of establishing regulations, that would require competitive bidding for government procurement. Given widespread noncompetitive practices that provide latitude for corrupt exchanges, progress on such reforms is essential.

Tendering procedures are typically non-transparent and inconsistent over time. Contracts below $100,000 are not usually tendered. For domestic procurement, Chinese enterprises increasingly compete via internal negotiations to supply projects. For international procurement not under World Bank guidelines, China may offer a project to a single bidder, a few, or as many bidders as it chooses. Bidders can be excluded for largely political reasons. For example, early in the 1990's, French companies had been virtually excluded from competing in several projects as a result of France's decision to sell fighter aircraft to Taiwan. Commonly, all eligible U.S. wheat exporters are invited to bid at China's U.S. wheat tenders. Procurement for some major purchases has apparently been awarded for political reasons, and single-source procurement -- including buying missions timed to influence political decisions in other countries -- is not uncommon.

China's government procurement procedures allow for preferential treatment of domestic suppliers, products and services. Domestic (Renminbi) procurement is often closed to foreign bidders. Even when open to foreign bidders, such suppliers may be discouraged from bidding by the uncertainty of obtaining foreign exchange. Moreover, the Chinese government routinely seeks to obtain offsets from foreign bidders in the form of local content requirements, technology transfers, investment requirements, counter-trade or other concessions, not required of Chinese firms. Bidding documents, including those for internationally-funded procurements, often express a "preference" for offsets. U.S. suppliers have pointed to this practice as one that distorts trade and investment decisions with China. Negotiation among a field of competitors narrowed by selection is frequently used to try to extract additional concessions from bidders. Such negotiations appear to focus as much on offsets as price, quality, and other technical and directly related economic factors. The Chinese do not necessarily conduct the negotiations on an equal basis with all bidders, but rather may focus their efforts on a principal bidder and try to use concessions from other bidders to extract further concessions from this bidder.

The size and rate of growth of the Chinese economy, the proportion of the economy still falling under State control, and demand for the type of high technology goods and services that the United States provides all indicate that government procurement contracts would offer extremely significant commercial opportunities if current restrictions were removed. Sectors of highest demand include infrastructure development (especially energy, petrochemicals, transportation and environmental protection), telecommunications and value-added services, machinery, electrical equipment and precision instruments, and certain agricultural and forest products.

EXPORT SUBSIDIES

The Chinese Government claims that direct financial subsidies for all exports, including for agricultural goods, ended as of January 1, 1991. Nevertheless, Beijing still uses a mixture of subsidies to promote exports, including low-priced energy, and raw materials. State enterprises and state trading companies, many of which are significant if not exclusive exporters, have received bank loans on preferential terms or have not been penalized for late payments or outright failure to repay loans.

State trading companies cross-subsidize certain exports in order to generate foreign exchange. Prices in the Chinese domestic market for some of these products are so high, however, that Chinese enterprises lose their incentive to export. To encourage exports, state trading companies subsidize the difference between the low world price and the higher domestic price. While the enterprises do not receive any additional profits per product sold, the practice does encourage them to export. This artificial incentive to export disrupts normal trade flows. Local content and export performance requirements (or expectations) also are frequently features of China's industrial policies. Such policies constitute subsidies to the extent that, as part of the industrial policy package, receipt of financial and other benefits is tied to a performance requirement.

Other export incentives that may be regarded as subsidies include tax incentives for exporters, with additional preferences for firms operating in China's special economic zones and coastal cities. In 1995, China announced reductions in the rate of rebates paid on value-added tax on goods that are exported, and further reductions are to take place in 1996. Preferential policies available to firms in the special economic zones and coastal cities may be revised in 1996. China continues to provide financial subsidies for development programs for products that are eventually exported. Soda ash has been one example.

INTELLECTUAL PROPERTY RIGHTS PROTECTION

The 1995 IPR Enforcement Agreement, comprised of an exchange of letters and China's action plan, commits China to take effective measures to substantially reduce IPR piracy, particularly of copyrighted, trademarked and patented products. Over the long term, China will also create a new IPR enforcement structure, and provide market access for audiovisual products, computer software, and books and periodicals.

As part of China's commitment to substantially reduce piracy, China established a 9-month special enforcement period during which central and local governments were to launch an intense crackdown on major pirates of copyrighted works and trademarked products. China took many actions at the retail level to curb sales of IPR-infringing goods -- including conducting thousands of raids and destroying millions of pirated CDs, CD-ROMs, and other audiovisual and computer software products. In 1995 China established high level task forces at the policy level and strike forces in major urban areas to combat IPR piracy. These task forces are to remain in effect for three to five years.

The 1995 IPR enforcement agreement also established new rules for border enforcement, a copyright verification system for audiovisual products and CD-ROMs incorporating computer software, separate and detailed plans to clean up the audiovisual, books and periodicals and computer software sectors, a nationwide training and inspection system designed to prevent infringement, and a nationwide educational program on IPR protection. Finally, the 1995 agreement stipulates that U.S. companies will have access to China's domestic audiovisual and computer software markets. China committed to permit, for the first time, to establish joint ventures to produce, reproduce, distribute, sell and perform audiovisual works in China. Similarly, U.S. motion picture companies will be permitted to enter into revenue sharing arrangements with partners in China. China also agreed to abolish quotas for audiovisual productions, and make censorship requirements transparent.

To ensure effective implementation of the 1995 agreement, China and the United States committed to frequent consultations, exchanges of data on IPR enforcement activities, and publication of reports from each of China's new IPR task forces. U.S. government agencies and industry groups provided specialized IPR training and assistance to Chinese government agency personnel in 1995 pursuant to the agreement. Participation by foreign right holders in the enforcement of their IPR rights will make it possible to ensure and monitor implementation of the 1995 agreement.

By early 1996, it was clear that China made significant and, in some localities, effective efforts in the retail sector within China to begin to reduce piracy and counterfeiting. However, effective action against producers and major distributors of pirated audiovisual and computer software products has been lacking. U.S. and other foreign industry representatives reported that pirated and counterfeit goods exported from China to third markets continued at the same or even higher levels than before conclusion of the 1995 IPR enforcement agreement, and losses to IPR violations within China remain large and commercially deleterious for foreign right holders, with industry loss estimates for 1995 reaching $2.2 billion, in addition to losses suffered in third country markets. U.S. firms are not the only victims of IPR violations; for example, Hong Kong recording industry sales in Hong Kong appear to be shrinking due to pirated recordings crossing the border from China.

Serious concerns remain about China's implementation of the 1995 IPR Enforcement Agreement, and the United States has held frequent high-level discussions with Chinese officials to outline these concerns -- focused primarily on four key areas. First, effective action has not been taken against the at least 34 factories producing CDs, CD-ROMs, and video-CDs. Second, China customs border enforcement efforts have been inadequate, as are China customs regulations and rules for border enforcement of IPR. Third, expected improvements in market access for U.S. firms and products in the audiovisual (including motion pictures), sound recording and computer software sectors have not been realized as of early 1996. Finally, the United States has requested that the special enforcement period be extended so as to achieve concrete and identifiable reductions in the production, distribution, and sale of pirated products with special emphasis on the provinces, cities, and localities where infringement is most prevalent, for example, in southern China's Guangdong province .

Since the 1995 agreement was signed, USTR has held at least 18 meetings and IPR enforcement consultations with China. Specific actions needed to address present inadequacies in China's implementation of the IPR enforcement agreement have been identified and discussed for the four areas of concern outlined above. China's implementation of the 1995 IPR Enforcement Agreement has been the subject of a thorough USTR review since the one-year anniversary of the signing of that Agreement.

SERVICES BARRIERS

China's market for services remains severely restricted. Foreign service providers are only allowed to operate under selective "experimental" licenses and are restricted to specific geographic areas. As in other sectors, the absence of transparency and a sound legal and regulatory structure, and public ignorance of those laws and regulations that do exist, hinders market access for services companies.

China denies U.S. and other foreign companies national treatment, for example. U.S. services companies continue to face significant administrative restrictions when attempting to operate in China. U.S. financial institutions, law firms and accountants, among others, must largely limit their activities to serving foreign firms or joint ventures. U.S. companies still are not permitted to offer after-sales services, except in collaboration with a Chinese partner. Although some U.S. companies, such as those involved in joint-ventures, are allowed to hire and fire based on demand and performance and pay wages according to market rates, the representative offices of U.S. service suppliers are still required to hire, recruit or register all local staff through state labor services companies which collect large monthly fees for each employee hired. Access to distribution outlets remains severely restricted, with Chinese distributors often having an economic incentive to market products other than those offered by U.S. companies, even those based in China.

China has expressed an intention to liberalize its services markets eventually, and in some cases, has begun to do so on a trial basis. China has licensed some U.S. law firms, but limited their practice to a single city and forbids them from taking Chinese clients, appearing in Chinese courts or establishing joint-venture law firms. Travel and other tourist-related companies offering travel services are limited to 11 areas in China, and retailing firms are subject to vague guidelines that are restrictive and the implementation of which often varies considerably from locality to locality.

In areas such as financial services, restrictions continue to impede market access. U.S. and other foreign financial institutions require case-by-case approval for new representative offices and branches. As of the end of 1995, a total of 137 foreign bank branches and 519 representational offices had been approved. Foreign financial institutions may not engage in local currency business. In January 1996, however, the State Council announced it would give the go-ahead for some foreign banks in Shanghai's Pudong area to apply for a license to conduct RMB transactions on a restricted trial basis.

China has passed an insurance law and is taking steps to reform and develop its domestic insurance industry, but still blocks nearly all foreign companies from the market. While China has approved to date 119 representative offices opened by 77 different foreign insurance companies, including many large U.S. insurers, only one U.S. company and one Japanese company have been granted licenses to operate in China. However, the licenses granted the U.S. company, which allow it to operate only in Shanghai and Guangzhou, restrict the company to a narrow range of operations. Permission to compete directly with the state-run insurance company, the People's Insurance Company, or with other quasi-private Chinese companies such as Ping An or China Pacific, has not been granted. While U.S. companies suffer such restrictions, new Chinese insurance conglomerates have been given free rein to set up operations and take market share.

In other areas, such as information and telecommunications services, U.S. companies continue to be closed out of the market. Regulations governing providers of telecommunications services and value-added telecommunications services limit the management or ownership of these types of services to domestic companies. Yet while U.S. companies have abided by the rules, there is evidence that Hong Kong and other foreign companies have established revenue-sharing arrangements with provincial officials to offer information and telecommunication services. in addition, in early 1996 the State Council announced new regulations restricting foreign providers of financial news services, placing them under the control of the State-run Xinhua News Agency.

INVESTMENT BARRIERS

Although official Chinese government policy welcomes foreign investment as critical to China's economic development plans, the Chinese Government maintains barriers and controls on foreign investment, channeling it toward areas that support Chinese government development policies. China encourages foreign investment in priority infrastructure sectors such as energy production, communications, and transportation, and restricts or prohibits it in sectors where China's planners have determined that China does not have a specific need or where China is attempting to protect the local industry. In June 1995, Chinese authorities issued investment "guidelines" detailing sectors in which investment is encouraged, restricted or prohibited. The new guidelines were a positive step toward clarifying China's policies on foreign investment. However, a continued general lack of transparency in the foreign investment approval process and inconsistency in the implementation of regulations continue to hinder investors that meet the substantive requirements of the "guidelines."

As the investment guidelines illustrated, the Chinese Government still prohibits foreign investment for projects with objectives not in line with the state's national economic development plans. In addition, there are many areas in which, although foreign investment is technically allowed, it is severely restricted. Restricted categories generally reflect: (1) the protection of domestic industries, such as the services sector, in which China fears that its domestic market and companies would be quickly dominated by foreign firms; (2) the aim of limiting luxuries or requiring large imports of components or raw materials; and (3) the avoidance of redundancy (i.e., excess capacity).

Examples of investment restrictions are abundant. Citing a "national security interest," China also bans investment in the management and operation of basic telecommunications, all aspects of value-added telecommunications as well as in the news media, broadcast and television sectors. China severely restricts investment in the rest of the services sector, including distribution, trade, construction, tourism and travel services, shipping, advertising, insurance and education. Finally, China hinders foreign investment and distorts trade by insisting on fulfillment of contract-specific local content, foreign exchange balancing, and technology transfer requirements. Furthermore, foreign enterprises are often limited in their scope. Generally, they are prohibited from directly importing and reselling goods without further processing.

The Chinese government has taken steps to address investors' complaints regarding the inadequacies of protection for foreign investment. While amending its joint venture law to prohibit the expropriation or nationalization of joint ventures without cause and compensation, the law continues to fall short of international standards sought by the United States. Other legislative actions taken by Beijing have promised greater autonomy and incentives for foreign-invested ventures. The enforcement of Chinese laws, however, is more a function of the political environment and the interest that senior leaders have in seeing the law implemented than it is of the legislature having enacted it.

The day-to-day problems for foreign ventures still lie in the uncertain investment climate created by frequent, unannounced policy changes as well as the uneven implementation of laws and regulations. In addition, the designation of key state enterprises in many industries as the exclusive bases for the development of critical technologies limit the choice of joint venture partners. Designated partners are frequently unattractive for various business reasons, such as lack of experience, inappropriate staffing levels, and outdated equipment.

Overall, however, foreign-invested enterprises have a significantly greater degree of managerial autonomy than do typical Chinese enterprises. On the other hand, Chinese enterprises enjoy certain advantages because they are fully integrated into the national economic system. Central government ministries and local governments frequently provide special advantages to state-owned firms. For example, many Chinese companies are able to obtain preferential treatment in local financing, marketing, setting prices, and purchasing raw materials. Unlike many U.S. companies in China, Chinese companies have free access to the Chinese domestic market.

For many companies, the highly personalized nature of business in China and the limited number of suppliers and customers often make arbitration or other legal remedies impractical. Even when they have strong cases, foreign investors often decide against using arbitration or other legal means to resolve problems out of fear of permanently alienating critical business associates for government authorities. The lack of recourse to an impartial legal system that is not susceptible to Chinese government pressure further undermines investor confidence.

In December, 1992, the United States re-established the Joint Commission on Commerce and Trade (JCCT) as a ministerial-level forum for discussion of investor and business concerns, among other things. The JCCT met most recently in October 1995 with working group sessions on trade and investment in a number of sectors. These working groups have established and continue to coordinate a range of cooperative exchanges on trade and investment issues, providing a forum to discuss specific investor and business problems.

ANTI-COMPETITIVE PRACTICES

China's first law on unfair competition went into effect at the beginning of December 1993. Article 8 of the law forbids the use of money and materials or other means as bribes to sell goods but allows discounts or commissions openly offered and properly recorded. The law provides for fines, confiscation of gains, and criminal penalties "according to law."

Criminal penalties against bribery and corruption were established in a 1988 provision. The same year also saw adoption of sanctions for corruption and bribery by state administrative personnel and provisions prohibiting acceptance of gifts, including gifts associated with purchase of goods, by administrative officials. However, these laws and regulations in many cases appear to be observed in the breach. Public anger at official corruption resulted in the adoption of the 1988 regulations.

By early 1995, official campaigns against corruption had resulted in arrests of several high officials, indicating that the problem persists. In early 1996, government and communist party leaders continue to call for improved self-discipline and anti-corruption efforts by officials and party cadres at all levels.

For procurements made using competitive procedures, there is little direct evidence that bribery or corrupt practices have influenced awards or resulted in competitive measures not being enforced. However, competitive procedures are not followed for the majority of procurements in China. The likelihood of corruption or bribery affecting domestic procurements appears significant, given the Chinese government's own campaign to attack widespread corrupt practices of officials. U.S. suppliers have complained that such practices in China put them at a competitive disadvantage.

From comments by business people, reports in the press, and statements by Chinese officials, bribery and corruption are not confined to certain geographic areas or industrial sectors but are fairly widespread. U.S. suppliers have frequently raised this problem with U.S. officials, noting that it puts them at a commercial disadvantage compared to nationals of other countries without legal constraints against such practices. While this problem is less severe in sectors where the United States holds clear technological preeminence or cost advantages, it does undermine the long-term competitiveness of U.S. suppliers in the Chinese market.

In order to improve the profitability of state-owned enterprises, China has encouraged the formation of industrial conglomerates. In some cases, the government has provided subsidies and other public benefits to such conglomerates. Semi-public industry "associations" may sometimes be authorized to fix prices, allocate contracts and, in other ways, restrict competition among domestic suppliers. Such monopolistic or monopsonistic practices may restrict market access for imported products and raise production costs and restrict market opportunities for foreign-invested enterprises in China.

OTHER BARRIERS

The goal of achieving transparency and uniformity of application of trade rules throughout China remains elusive. The 1992 bilateral market access MOU commits China to take significant steps to improve transparency, including the publication of a central repository for all central government trade regulations and publications in the provinces of all trade and investment-related trade regulations. While the MOFTEC Gazette was established to carry official texts of all trade-related laws and regulations at the national level -- and has been a significant step toward transparency -- its coverage of trade-related regulations has been incomplete and it is not always timely. In addition, important steps toward making the import approval process transparent, especially for industrial goods such as machinery and electronics products, are offset by the opaque nature of customs and other government procedures. The charters and responsibilities of many state organizations involved in trade are often opaque or subject to dispute by competing government organizations in Beijing and the provinces.

General foreign exchange balancing requirements still have the potential to distort trade and constrain foreign-invested businesses in China. In the past, Chinese authorities have used a variety of means to control the allocation of foreign exchange for trade and other transactions. These restrictions included a requirement that Chinese enterprises surrender their foreign exchange earnings to the central government as well as restrictions on access to foreign exchange swap centers. China's currency, the Renminbi, is conditionally convertible for authorized trade and current account transactions. Many past and current Chinese officials expressed opinions publicly in late 1995 about how soon -- the year 2000 or earlier -- China might be able to make its currency freely convertible on its current account.

China currently maintains separate foreign exchange rules for foreign-invested enterprises (FIES), which can maintain foreign currency deposits and keep their foreign exchange earnings. At present, FIEs generally have good access to foreign exchange. However, FIEs are excluded from the large "interbank" foreign exchange market and required to buy and sell foreign exchange from each other in a modified version of the old swap center. In practice, most FIEs buy and sell foreign exchange using designated foreign exchange banks, including branches of foreign banks, as their agents. These transactions are completed over the same trading system and exchange rates used by Chinese banks for domestic customers. The Chinese government has indicated that the swap centers will be eliminated and FIEs are expected to have equal access to a unified interbank market in the near future.

The explosive growth of many markets in China, while a very positive sign for China's economy as a whole, has led to the creation of large gray markets in some sectors of great commercial interest to U.S. producers and exporters. While some U.S. products are traded in the gray market, most firms either cannot or choose not to accept the risks of entering this market. U.S. firms are therefore denied full access to some of China's most lucrative markets, and continue to operate within the more restrictive state-controlled sectors. For example, lack of access to the gray market in medical equipment denies sales to U.S. companies that market state-of-the-art equipment, and cedes market share to foreign competitors that do not face similar restrictions. Restrictive import licensing requirements for low-end computers, only tardily lifted in mid-1995, appeared to allow third country competitors to make inroads in a market that is dominated elsewhere by U.S. manufacturers.

Smuggling into China constitutes a formidable disincentive to import U.S. and other foreign products -- and harms U.S. exporters in several ways. Smuggling diverts income from U.S. joint ventures in China or their home operations. Smuggling deprives U.S. companies of the opportunity to ensure quality standards and, because of the often poor quality of smuggled goods, tarnishes the reputation of the company and prejudices Chinese consumers against those products, sometimes even before the U.S. producer has had a legitimate opportunity to enter the Chinese market. Smuggling creates havoc for companies that try to provide after sales service and repairs. Smuggled goods do not carry warranties, are often damaged or handled poorly, and are not serviced by trained personnel. Smuggling, especially but not only in southern China, fuels corruption and degrades China's already imperfect regulatory environment.

OTHER SERVICES

Satellite Launch Services

On March 13, 1995, the United States and China signed an agreement renewing the bilateral agreement on international trade in commercial space launch services. The agreement covers the period from 1995 to 2001 and continues quantitative and pricing disciplines established under the first U.S.-China space launch services agreement signed in 1989.

The renewed agreement limits China to no more than 11 launches to geosynchronous earth orbit (GEO) over the seven-year period of the agreement. In addition, it allows four launches in 1995-95 to be counted against the quota of the first agreement since they had already been reviewed under that agreement. China conducted only four of its permitted nine launches in 1989-1994.

In light of the emergence of the remote-sensing and weather tracking market for launches to low-earth -orbit (LEO) since 1989 and commercial plans for the deployment of telecommunications satellite constellations into LEO beginning in 1997, the renewed Chinese agreement contains specific disciplines and guidelines regarding future Chinese launches to LEO. The agreement requires that Chinese participation in the LEO market segment be proportionate and non-disruptive. The United States may request consultations with China to establish the facts and agree on any necessary corrective action.

The 1995 agreement contains new language which more clearly describes the circumstances under which adjustments to the GEO quota may be made. For example, the GEO restrictions may be increased as a result of stronger than predicted growth for geo launch services or the lack of availability of western launch services during a specified launch period. By providing this greater detail, the agreement should achieve its intended objective with respect to the U.S. space launch industry while balancing the needs of U.S. satellite manufacturers and users.

While the Chinese launches remained well below their quantitative limit in during the first agreements, concerns have been raised about the consistency of their pricing with provisions of the old agreement which require that the Chinese offer launch services at prices on a par with those prices, terms, and conditions prevailing in the international market for comparable commercial launch services. In light of these concerns, the renewed agreement contains two improvements to the GEO pricing discipline; 1) a detailed annex on the adjustments which might be appropriate to make when comparing Chinese and Western launch prices and average values associated with those adjustments, and 2) a safe harbor which provides that Chinese prices falling within 15 percent of Western prices will generally be assumed to be in compliance with the "par pricing" standard of the agreement, unless facts indicate otherwise. The former improvement will help prevent disputes with China on the nature and value of price adjustments, while the latter should aid in focusing attention on those transactions which could threaten the integrity of the "par pricing" discipline. The combined result of these changes will be to improve the timing and effectiveness of U.S. monitoring of Chinese prices for launch services.

The LEO pricing disciplines consists of the same par pricing requirement as in GEO. The two sides have been working over the last year to reach a consensus on specific LEO pricing adjustments as have already been negotiated on GEO.

 
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