Letter from Washington

Measuring Success at the Upcoming Dialogue

by John Frisbie

The second session of the Strategic Economic Dialogue (SED) later this month will bring PRC Vice Premier Wu Yi to Washington, DC, with as many as 10 PRC government ministers, to meet with US counterparts on ways to strengthen US-China commercial and economic relations over the long term. Though the agenda was just firming up as CBR went to press, my experience at the China Development Forum conference earlier this spring confirms my view that the SED is the best way to achieve real progress on a number of issues important to both sides, especially against the backdrop of recent actions by the US government involving countervailing duties and intellectual property rights.

China's priorities

The annual China Development Forum, organized by the State Council's Development Research Center, brings together CEOs, leading economists, and association heads with PRC government leaders and economists. This year's forum, the eighth, featured presentations by leading policymakers, including Vice Premier Zeng Peiyan, National Development and Reform Commission Chair Ma Kai, China Banking Regulatory Commission Chair Liu Minkang, Minister of Health Gao Qiang, and Minister of Commerce Bo Xilai. The foreign delegates also met with Premier Wen Jiabao.

The theme and content of this year's forum was establishing a new model for sustainable economic growth in China. Discussions surrounded two main policy goals: first, shifting to a more balanced and sustainable economic growth model that increases the role of domestic demand and reduces reliance on exports and fixed-asset investment; and second, improving energy efficiency and cutting environmental pollution over the next five years.

PRC leaders have been talking about these two policy goals for some time, with little tangible progress made on either front. I listened carefully for specific new measures that might show results, but the PRC presenters largely avoided such details. Nonetheless, both policies were rolled out with an urgency I had not heard before, perhaps suggesting stronger measures to come.

A new growth model

Policymakers recognize that export processing no longer presents the growth and employment opportunities it once did. Surplus labor is dwindling in some sectors and areas, wage rates are rising, the renminbi is appreciating against the US dollar, and future competitiveness will have to come from increasing productivity. High levels of fixed-asset investment add unneeded capacity, eat up materials, and use excessive energy. The result is pressure on resources, environmental pollution, and a growing trade surplus that threatens to provoke a protectionist backlash from China's trading partners.

All attendees agreed that a shift in its economic growth model would benefit China. In fact, China's leaders have been pledging in recent years to take steps to raise consumption. The government raised the personal income tax exemption and eliminated some taxes and surcharges on farmers. But these limited moves have failed to spur consumption significantly. Though consumption has been rising about 12 percent a year in recent years, it has failed to keep pace with other drivers of the economy, particularly investment. As a share of GDP, consumption has slipped from about 40 percent in 2002 to roughly 36 percent in 2006, while fixed-asset investment's share of GDP has risen from about 29 percent to nearly 50 percent.

Speakers at the forum all recognized that the root cause of China's high savings rate is the lack of a strong social safety net. Chinese must save for basic healthcare, education, and retirement. An undeveloped consumer credit system means they have to save for purchases, too. To free up these "trapped" savings and increase domestic demand, China must press forward with tougher, deeper reforms in these areas.

But achieving a more balanced economy requires reform to extend beyond measures aimed at consumers. To prevent them from simply investing in new capacity, companies need other options for investing or distributing retained earnings. Small and medium-sized enterprises need better access to credit so that they do not have to save to finance inventory, for example. And a corporate bond market would help channel capital more efficiently.

Foreign presenters at the forum made a number of suggestions, many if not most of which have been discussed elsewhere. For example, some suggested eliminating the value-added tax (VAT) rebate system for exports and using the resulting budgetary savings to finance pension, healthcare, and education reform to ease consumer worries and stimulate spending. Other speakers recommended that the government require state-owned enterprises (SOEs) to pay dividends. Not only would this discourage SOEs from reinvesting retained earnings in excess capacity, but the government could use the extra revenue to finance transfer payments to the social safety net.

Foreign and PRC speakers mentioned the need to develop China's service sector, which constitutes only about 40 percent of GDP. (In contrast, services accounts for nearly 80 percent of US GDP.) Service sector growth would use fewer resources and create jobs. The China Business Forum, the educational and research arm of the US-China Business Council (USCBC), recently released a study by Oxford Economics Ltd. that highlights the benefits of a more open PRC service sector to both the US and PRC economies. The report finds that if the impediments to service sector growth in China were fully removed, the average Chinese household would be better off by $300-$400 per year by 2015. The benefit would amount to an additional $138 billion in GDP for China (in 2006 prices) and create employment for 7 million persons. Perhaps as a sign of follow-through, China announced a new policy in early April to develop the service sector, with the formation of a leading group to drive the policy.

Urgency about energy and the environment

Government speakers also highlighted several familiar measures aimed at improving the environment: China will use administrative means to shut down low-capacity and inefficient power, steel, and paper plants. To help reduce the trade surplus and investment in resource-consuming sectors, VAT rebates on exports could be eliminated or reduced for certain products—again, steel and other metals and minerals.

Speakers provided somewhat greater detail on ways to achieve more efficient use of resources and cut pollution—a subject that was brought up in every presentation. Premier Wen reiterated PRC goals of cutting energy use per unit of GDP by 20 percent in the next five years and cutting pollutants by 10 percent. Developing the service sector would help achieve these goals, presenters noted. Introducing market-based pricing for energy, water, and other resources would help tremendously, but PRC government speakers acknowledged this would occur only gradually. Fiscal policy will be used to encourage conservation by increasing tax rates on scarce resources and establishing a market-oriented land pricing system.

Convergence with the SED

China's priorities as outlined at the China Development Forum dovetail with the focus of the SED, which includes initiatives on healthcare, energy, and services, to name a few. The lack of specifics of how China will achieve its goals also, paradoxically, could be an opportunity for the SED to stimulate ideas and suggest policy directions that, ultimately, would lead to a reduction in bilateral tensions and constructive progress on the overall relationship. Reforms that develop market-based lending and repayment would help level the playing field. Providing alternatives to capacity expansion (and the resulting pressure on margins) for retained earnings distribution would do the same. Further financial system reforms that allow China to remove capital controls would enable China to move to a fully convertible and market-driven exchange rate—the ultimate solution to the exchange rate issue. Finally, boosting domestic demand might—eventually—help with the trade balance.

US Treasury Secretary Henry Paulson has rightly focused the SED on these and other topics that align with China's stated reform desires. The catch is that none of this will happen fast enough to satisfy the US Congress and other critics who see China as the source of the US trade deficit and economic insecurity.

Constructive dialogue is the best opportunity to keep this relationship moving forward.

For that reason, in my meetings in Beijing in the days following the forum, I described to PRC officials the reality of pressures resulting from the trade deficit and other issues and explained that Congress is likely to watch how the May SED goes before deciding whether to move forward with legislation. I made clear that although the SED rightly focuses on broader, longer-term issues, the dialogue needs to show markers of progress along the way—to ensure that the SED, in fact, continues. For example, the release of more draft laws for public comment could signal progress on the issue of government transparency.

But expectations, or demands, from some quarters that the SED solve all of our trade issues in May are misguided. Those expectations, as well as the number of cabinet- and minister- rank officials involved and the attention that such high- profile participation brings to the meetings, mean that the SED carries the risk of a bar set too high. Constructive dialogue, however, has proven to be, and remains, the best opportunity to keep this relationship—and, to the extent external influence is effective, China's reforms—moving forward. The SED is enormously important to establishing a framework to keep our most important economic and commercial relationship on the right track, and the USCBC will do what it can to ensure its success.

John Frisbie is president of the US-China Business Council.

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	E-Mail \| Print \| License Letter from Washington Measuring Success at the Upcoming Dialogue by John Frisbie The second session of the Strategic Economic Dialogue (SED) later this month will bring PRC Vice Premier Wu Yi to Washington, DC, with as many as 10 PRC government ministers, to meet with US counterparts on ways to strengthen US-China commercial and economic relations over the long term. Though the agenda was just firming up as CBR went to press, my experience at the China Development Forum conference earlier this spring confirms my view that the SED is the best way to achieve real progress on a number of issues important to both sides, especially against the backdrop of recent actions by the US government involving countervailing duties and intellectual property rights. China's priorities The annual China Development Forum, organized by the State Council's Development Research Center, brings together CEOs, leading economists, and association heads with PRC government leaders and economists. This year's forum, the eighth, featured presentations by leading policymakers, including Vice Premier Zeng Peiyan, National Development and Reform Commission Chair Ma Kai, China Banking Regulatory Commission Chair Liu Minkang, Minister of Health Gao Qiang, and Minister of Commerce Bo Xilai. The foreign delegates also met with Premier Wen Jiabao. The theme and content of this year's forum was establishing a new model for sustainable economic growth in China. Discussions surrounded two main policy goals: first, shifting to a more balanced and sustainable economic growth model that increases the role of domestic demand and reduces reliance on exports and fixed-asset investment; and second, improving energy efficiency and cutting environmental pollution over the next five years. PRC leaders have been talking about these two policy goals for some time, with little tangible progress made on either front. I listened carefully for specific new measures that might show results, but the PRC presenters largely avoided such details. Nonetheless, both policies were rolled out with an urgency I had not heard before, perhaps suggesting stronger measures to come. A new growth model Policymakers recognize that export processing no longer presents the growth and employment opportunities it once did. Surplus labor is dwindling in some sectors and areas, wage rates are rising, the renminbi is appreciating against the US dollar, and future competitiveness will have to come from increasing productivity. High levels of fixed-asset investment add unneeded capacity, eat up materials, and use excessive energy. The result is pressure on resources, environmental pollution, and a growing trade surplus that threatens to provoke a protectionist backlash from China's trading partners. All attendees agreed that a shift in its economic growth model would benefit China. In fact, China's leaders have been pledging in recent years to take steps to raise consumption. The government raised the personal income tax exemption and eliminated some taxes and surcharges on farmers. But these limited moves have failed to spur consumption significantly. Though consumption has been rising about 12 percent a year in recent years, it has failed to keep pace with other drivers of the economy, particularly investment. As a share of GDP, consumption has slipped from about 40 percent in 2002 to roughly 36 percent in 2006, while fixed-asset investment's share of GDP has risen from about 29 percent to nearly 50 percent. Speakers at the forum all recognized that the root cause of China's high savings rate is the lack of a strong social safety net. Chinese must save for basic healthcare, education, and retirement. An undeveloped consumer credit system means they have to save for purchases, too. To free up these "trapped" savings and increase domestic demand, China must press forward with tougher, deeper reforms in these areas. But achieving a more balanced economy requires reform to extend beyond measures aimed at consumers. To prevent them from simply investing in new capacity, companies need other options for investing or distributing retained earnings. Small and medium-sized enterprises need better access to credit so that they do not have to save to finance inventory, for example. And a corporate bond market would help channel capital more efficiently. Foreign presenters at the forum made a number of suggestions, many if not most of which have been discussed elsewhere. For example, some suggested eliminating the value-added tax (VAT) rebate system for exports and using the resulting budgetary savings to finance pension, healthcare, and education reform to ease consumer worries and stimulate spending. Other speakers recommended that the government require state-owned enterprises (SOEs) to pay dividends. Not only would this discourage SOEs from reinvesting retained earnings in excess capacity, but the government could use the extra revenue to finance transfer payments to the social safety net. Foreign and PRC speakers mentioned the need to develop China's service sector, which constitutes only about 40 percent of GDP. (In contrast, services accounts for nearly 80 percent of US GDP.) Service sector growth would use fewer resources and create jobs. The China Business Forum, the educational and research arm of the US-China Business Council (USCBC), recently released a study by Oxford Economics Ltd. that highlights the benefits of a more open PRC service sector to both the US and PRC economies. The report finds that if the impediments to service sector growth in China were fully removed, the average Chinese household would be better off by $300-$400 per year by 2015. The benefit would amount to an additional $138 billion in GDP for China (in 2006 prices) and create employment for 7 million persons. Perhaps as a sign of follow-through, China announced a new policy in early April to develop the service sector, with the formation of a leading group to drive the policy. Urgency about energy and the environment Government speakers also highlighted several familiar measures aimed at improving the environment: China will use administrative means to shut down low-capacity and inefficient power, steel, and paper plants. To help reduce the trade surplus and investment in resource-consuming sectors, VAT rebates on exports could be eliminated or reduced for certain products—again, steel and other metals and minerals. Speakers provided somewhat greater detail on ways to achieve more efficient use of resources and cut pollution—a subject that was brought up in every presentation. Premier Wen reiterated PRC goals of cutting energy use per unit of GDP by 20 percent in the next five years and cutting pollutants by 10 percent. Developing the service sector would help achieve these goals, presenters noted. Introducing market-based pricing for energy, water, and other resources would help tremendously, but PRC government speakers acknowledged this would occur only gradually. Fiscal policy will be used to encourage conservation by increasing tax rates on scarce resources and establishing a market-oriented land pricing system. Convergence with the SED China's priorities as outlined at the China Development Forum dovetail with the focus of the SED, which includes initiatives on healthcare, energy, and services, to name a few. The lack of specifics of how China will achieve its goals also, paradoxically, could be an opportunity for the SED to stimulate ideas and suggest policy directions that, ultimately, would lead to a reduction in bilateral tensions and constructive progress on the overall relationship. Reforms that develop market-based lending and repayment would help level the playing field. Providing alternatives to capacity expansion (and the resulting pressure on margins) for retained earnings distribution would do the same. Further financial system reforms that allow China to remove capital controls would enable China to move to a fully convertible and market-driven exchange rate—the ultimate solution to the exchange rate issue. Finally, boosting domestic demand might—eventually—help with the trade balance. US Treasury Secretary Henry Paulson has rightly focused the SED on these and other topics that align with China's stated reform desires. The catch is that none of this will happen fast enough to satisfy the US Congress and other critics who see China as the source of the US trade deficit and economic insecurity. Constructive dialogue is the best opportunity to keep this relationship moving forward. For that reason, in my meetings in Beijing in the days following the forum, I described to PRC officials the reality of pressures resulting from the trade deficit and other issues and explained that Congress is likely to watch how the May SED goes before deciding whether to move forward with legislation. I made clear that although the SED rightly focuses on broader, longer-term issues, the dialogue needs to show markers of progress along the way—to ensure that the SED, in fact, continues. For example, the release of more draft laws for public comment could signal progress on the issue of government transparency. But expectations, or demands, from some quarters that the SED solve all of our trade issues in May are misguided. Those expectations, as well as the number of cabinet- and minister- rank officials involved and the attention that such high- profile participation brings to the meetings, mean that the SED carries the risk of a bar set too high. Constructive dialogue, however, has proven to be, and remains, the best opportunity to keep this relationship—and, to the extent external influence is effective, China's reforms—moving forward. The SED is enormously important to establishing a framework to keep our most important economic and commercial relationship on the right track, and the USCBC will do what it can to ensure its success. John Frisbie is president of the US-China Business Council. Further Reading Letter from Shanghai: The Prodigal Prodigy Letter from Washington: The New Congress Click here for copyright permissions Copyright 2007 US-China Business Council Top of Page Table of Contents
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