2013 Report To Congress Of The U.S.-China Economic And Security Review Commission

ONE HUNDRED THIRTEENTH CONGRESS
FIRST SESSION

NOVEMBER 2013

This report responds to the mandate for the Commission "to monitor, investigate, and report to Congress on the national security implications of the bilateral trade and economic relationship between the United States and the People’s Republic of China." In this Report, the Commission reached a broad and bipartisan consensus, approving the Report by a vote of 11 ayes to 1 nay.

In accordance with our mandate, this Report, which is current as of November 13, includes detailed treatment of our investigations of the areas identified by Congress for our examination and recommendation.

These areas are:

• PROLIFERATION PRACTICES—The role of the People’s Republic of China in the proliferation of weapons of mass destruction and other weapons (including dual-use technologies), including actions the United States might take to encourage the People’s Republic of China to cease such practices;
• ECONOMIC TRANSFERS—The qualitative and quantitative nature of the transfer of United States production activities to the People’s Republic of China, including the relocation of high technology, manufacturing, and research and development facilities, the impact of such transfers on United States national security, the adequacy of United States export control laws, and the effect of such transfers on United States economic security and employment;
• ENERGY—The effect of the large and growing economy of the People’s Republic of China on world energy supplies and the role
the United States can play (including joint research and development efforts and technological assistance), in influencing the energy policy of the People’s Republic of China;
• UNITED STATES CAPITAL MARKETS—The extent of access to and use of United States capital markets by the People’s Republic of China, including whether or not existing disclosure and transparency rules are adequate to identify People’s Republic of China companies engaged in harmful activities;
• REGIONAL ECONOMIC AND SECURITY IMPACTS—The triangular economic and security relationship among the United States, [Taiwan] and the People’s Republic of China (including the military modernization and force deployments of the People’s Republic of China aimed at [Taiwan]), the national budget of the People’s Republic of China, and the fiscal strength of the People’s Republic of China in relation to internal instability in the People’s Republic of China and the likelihood of the externalization of problems arising from such internal instability;
• UNITED STATES–CHINA BILATERAL PROGRAMS—Science and technology programs, the degree of noncompliance by the People’s Republic of China with agreements between the United States and the People’s Republic of China on prison labor imports and intellectual property rights, and United States enforcement policies with respect to such agreements;
• WORLD TRADE ORGANIZATION COMPLIANCE—The compliance of the People’s Republic of China with its accession agreement to the World Trade Organization (WTO); and
• FREEDOM OF EXPRESSION—The implications of restrictions on speech and access to information in the People’s Republic of China for its relations with the United States in the areas of economic and security policy.

Introduction

While 2013 has been a year of leadership change for China, it is too early to say that the initial economic policy pronouncements will lead to quick reforms. Less heralded but longstanding and continuing improvements in China’s military capabilities, however, could have a major impact on the region.

The Chinese leadership accomplished a peaceful turnover during the past year, complicated by factional political maneuvering. The handoff for the new five-year term took place with both ceremony and caution. In the absence of immediate policy changes from the newcomers, the government in Beijing coasted on the momentum from the previous decade. While China’s economy slowed from a 30-year double-digit sprint to a more sustainable pace of 7.66 percent growth, Beijing’s new economic policymakers appear to be clinging to the old formula of exports and infrastructure projects and a strong state-controlled sector to boost employment and maintain the regime’s political control.

The Chinese renminbi continued to appreciate against the dollar but remains undervalued. The rise in the Chinese currency did not jeopardize China’s expanding trade surplus with the United States nor its growing foreign exchange reserves, which hit $3.66 trillion at the end of September. China’s new leaders, President and Party General Secretary Xi Jinping and Premier and Party Secretary of the State Council Li Keqiang, reaffirmed the government’s longpromised goal of shifting the economy to one more driven by domestic consumption. However, the major market-based tools and reforms that China could use to empower Chinese workers and consumers remain unused: opening China’s financial services sector to foreign investment; shrinking the size and number of state-owned enterprises; and expanding opportunities for private investment and savings beyond low interest-bearing deposits in state-owned banks or risky speculation in the volatile real estate market. Such moves by China would help reduce the growing trade imbalance with the United States and boost employment in America.

Also troublesome were the press reports in April 2013 of an official but secret party-approved directive known as ‘‘Document No. 9’’ that seeks to enhance party authority. Widely attributed to President Xi, the memo lists seven perils to be avoided, among them ‘‘Western constitutional democracy,’’ ‘‘universal values’’ of human rights, press freedom and independence from the government, pro-market ‘‘neo liberalism,’’ an independent judiciary, and ‘‘nihilist’’ criticisms of the Chinese Communist Party. U.S. companies investing in China reported the same problem areas as the year before. In a survey of the top ten problems experienced

by the foreign affiliates of U.S. companies, the majority were of the Chinese government’s making. U.S. companies cited competition with Chinese government-owned companies, onerous licensing procedures, lax intellectual property protections, discriminatory laws and standards, and restrictions on foreign investment.

After announcing with some fanfare a free trade zone in Shanghai, Beijing diluted its potential impact by exempting segments of 18 different sectors, such as construction, finance, and manufacturing, from foreign investment and imposing a variety of other restrictions, highlighting continued disputes within the government over the pace and direction of economic reform. Beijing’s leadership also reacted haltingly to the emerging problems in China’s lightly regulated shadow banking system, particularly the buildup of unsecured, off-balance sheet loans. The system has proliferated because China’s state-owned banking system still heavily favors government- run enterprises over the efforts of Chinese entrepreneurs and small- and medium-sized business owners. Without fundamental banking reform and expanded credit to private industry and consumers, China’s goal of economic diversification will remain stuck in low gear.

One positive development in bilateral trade has been agriculture, the only sector in which the United States enjoys a substantial trade surplus with China. U.S. food producers stand to benefit from China’s growing demand for consumer foods, especially meat products. But at present, China concentrates its imports on lower value-added bulk commodities while exporting consumer foods to the United States that pose significant safety risks.

Under its new political leadership, China’s actions in the East and South China Seas continued to increase tensions in the region. It is becoming clear China does not intend to resolve its maritime disputes through multilateral negotiations or the application of international laws and adjudicative processes but prefers to use its growing power in support of coercive tactics that pressure its neighbors to concede China’s claims.

Since the Commission’s 2012 Report, strong evidence has emerged that the Chinese government is directing and executing a large-scale cyber espionage campaign against the United States. China to date has compromised a range of U.S. networks, including those of the Department of Defense and private enterprises. These activities are designed to achieve a number of China’s broad security, political, and economic objectives, such as gathering intelligence, providing Chinese firms with an advantage over their competitors worldwide, advancing long-term research and development objectives, and gaining information that could enable future military operations.

Meanwhile, China continued to develop and field advanced military platforms and weapon systems. China’s comprehensive military modernization is altering the balance of power in the Asia Pacific, challenging decades of U.S. military preeminence in the region.

China in 2013 expanded and diversified its arsenal of weapon systems capable of placing U.S. ships, aircraft, and bases in the Western Pacific at risk. The People’s Liberation Army (PLA) also continued to pursue cyber, electronic warfare, and counterspace capabilities that will enable Beijing to degrade or disrupt the command, control, communications, computers, intelligence, surveillance, and reconnaissance that are essential to U.S. military power projection on behalf of its interests in the region. As these capabilities mature, the costs and risks to the United States of intervention in a potential regional conflict involving China will increase.

Furthermore, the PLA enhanced its regional power projection capabilities, improving Beijing’s ability to use force against Taiwan, Japan, and rival claimants in the South China Sea. This could increase China’s willingness to respond militarily to a perceived provocation or to consider preemptive attacks in a crisis involving Taiwan or China’s maritime sovereignty claims. Many of these scenarios could require the U.S. military to protect U.S. regional allies and partners as well as to maintain open and secure access to the air and maritime commons in the Western Pacific.

Most Asian countries welcomed the U.S. rebalance to Asia when it was announced by the Obama Administration in 2011. However, there is growing concern among U.S. allies and partners that the Department of Defense will be unable to follow through on its commitment to the rebalance due to declining defense budgets and continuing security challenges elsewhere.

The Commission’s Report addresses these and other issues in depth as it continues to monitor the evolving economic and security relationship between our two countries.