Using Foreign Relations to Promote Domestic Goals

by Daniel H. Rosen | August 25, 2015

President Xi Jinping will make a state visit to the United States in September. The bilateral relationship is much more important and complex today than it was when Xi first visited 30 years ago. Then, China was under-developed and had little trade or investment with the United States. Today bilateral trade has grown to more than US$ 590 billion annually – one of the largest two-way trade flows in the world – and American companies are major direct investors in China. Growing trade and investment with the United States helped China achieve its development goals over the past three decades, and those growing commercial flows will help China transition to moderately well-off status today. Xi can strengthen his domestic reform program through a bilateral investment treaty (BIT) with the United States, an agreement that would promote the interests of Chinese firms abroad and consumers at home. He can achieve this goal at his summit in Washington, if bureaucratic and protectionist interests do not get in the way.

Investment from China to the United States has grown quickly in recent years. At Rhodium Group, a private U.S. economic research firm, my colleagues and I have analyzed the rise of these flows. From only a modest value in the mid-2000s, over US$ 50 billion of Chinese acquisitions and new business investments have been undertaken to date, and this is growing by more than US$ 10 billion a year. Four-fifths of America’s 425 congressional districts host Chinese investors, with over 85,000 American jobs now directly related to those deals. This is having a positive impact on American attitudes toward China.

As he travels in the United States, Xi will meet some of the Chinese business leaders and local American officials making these investments possible. He may be surprised to hear most of them report that the investment approval process is easier in the United States than it is in China. And he will hear something else important too: the American public is getting to know China’s firms, and they like their new neighbors. Jobs, a stronger tax base and a connection to the international economy are benefits that every community – in the United States or China – appreciates.

At a time of growing U.S.-China political and security friction, this positive economic development is very important. It is also critical to Chinese companies. Many of them depend on exports to the United States, but until recently they had no direct contact with their customers there. They received a small profit from manufacturing, but better-known foreign companies made most of the money by dealing directly with American consumers. With rising production costs at home, many of these Chinese manufacturers risk losing their export markets if they do not establish a retail presence in America. For others, the opportunity to buy better technologies, do better research, or learn better management processes is what makes a U.S. investment urgent.

Foreign investment into China supports domestic policy goals as well. The Chinese people are the biggest beneficiaries of continued reform and opening up. China’s leaders learned two important lessons from past international opening. First, in almost every industry opened to foreign competition as part of World Trade Organization entry in 2001, Chinese firms continued to thrive and households enjoyed improvements in welfare and quality. In the industries that were kept on a negative list for more protection, such as financial services, health care, and industrial goods, such as steel, China and its consumers continued to be harmed by poor quality, overcapacity and financial burdens. And second, the longer reform is delayed the more costly it will be. Bad debts build up, workers fail to get retrained in time to change jobs, and new “sunrise industries” are forced to wait unnecessarily for capital and labor to become available.

A bold plan for accelerating reform was presented at the third plenum of the Communist Party’s 18th Central Committee in November 2013. China’s leadership has the advantage of experience from past successes in economic liberalization to help guide its work today. Starting in 1986, it took 14 years for the country to negotiate accession to the WTO, and even at the end of that process many special interests tried to claim that globalization and economic liberalization were foreign tricks that were counter to Chinese interests. Those arguments were attempts to protect a handful of firms and bureaucracies, not benefit the nation. In manufacturing, China had opened to foreign investment and greatly reduced tariffs from 1992 to 2000, even before joining the WTO, and instead of harming those industries and welfare, jobs, competitiveness, exports and innovation were improved. After WTO accession, the sectors that naysayers claimed would be harmed – such as agriculture, telecommunications and automotive – instead experienced strong success.

Xi, like his predecessors, can negotiate trade and investment benefits for China abroad by committing to do what he has already pledged to do at home: implement domestic reforms that benefit the Chinese people. However, in China (as in all nations), protected businesses and bureaucrats oppose reform because their personal welfare – not the greater good of China – is more important to them. They are not interested in using a BIT with the United States to increase the pace of reform in China, and they have lobbied Beijing’s negotiators not to make a bold offer to the United States which could actually lead to a deal. There are some conservatives in Washington who feel the same way, and have no interest in seeing Chinese reform gather speed.

The question for Xi’s trip to the United States is whether he will use the past strategy of surprising the world with a bold proposal to finish a negotiation, such as China brilliantly did to enter the WTO, or instead wait and see what can be achieved with the next American president. The commitments needed to achieve a U.S. deal are bold, but they are not concessions or sacrifices: they are steps that remove privileges held by vested interests and improve Chinese welfare overall, and they are steps Beijing must take regardless of what the United States or anyone else thinks. Some of those who stand to lose that protection are telling Xi that China has made enough commitments and the decision is up to U.S. President Barack Obama. That is not true. The BIT offer from China so far is seen in the United States as a step backward from the spirit of the third plenum decisions which bears Xi’s name, and without his leadership the opportunity to use these talks to speed up China’s domestic reform program will be lost.

Copyright 2015 Caixin.