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Business ties have moved from the margins to center stage in Sino-American relations over the past 25 years. But in the history of relations between the world's richest country and the world's largest developing country, the one constant has been that political considerations have limited and shaped actions in the economic realm. That is almost as true in 1998 as it was when President Nixon made his historic visit to Beijing in 1972.

In the immediate aftermath of the 1972 opening, business loomed small in the budding Sino-American relationship. On both sides, strategic concerns dominated calculations. President Nixon's primary objective in early 1972 was to isolate Hanoi to hasten a negotiated "peace with honor" in Vietnam. Over the longer run, President Nixon and his immediate successors nurtured the China tie as an integral part of a global strategy to counter the Soviet Union and its allies. This long-term strategy dovetailed nicely with PRC leader Mao Zedong's motivation to use the PRC opening to the United States as a counterweight to the Soviet military threat to China's north.

Though economic ties were viewed as a useful supple ment to the strategic initiative, enormous hurdles blocked the realization of significant business relations in the early years. For decades preceding the opening, the United States had led an international effort to isolate China economically, and in the process constructed an impressive array of laws and regulations to bar business with the PRC. At one point, for example, the US Department of the Treasury, which was responsible for implementing many of these laws, had to rule whether wigs made from the hair of Chinese emigres into Hong Kong were too "communist" to import into the United States.

PRC-imposed hurdles were equally large. Mao had sought for more than a decade to minimize China's economic ties abroad in the pursuit of national self-reliance. He feared dependence on any single foreign country for supplies of grain and other important goods and wanted to eliminate domestic knowledge of foreign lifestyles. Under Mao, China refused to assume foreign debt and lacked the legal infrastructure necessary to receive foreign investment. Moreover, the PRC educational system failed to develop individuals with knowledge of international economic practices, and China's industry produced few exportable items.

Given such barriers, the early years after 1972 would have seen only limited Sino-US business ties develop even if the leaders of both sides had prioritized commercial relations. Trade levels in the 1970s remained very modest, with the balance tilted in favor of the United States (see Table). Because of the overwhelming focus on the strategic importance of the relationship, this attenuated economic development caused little consternation.

Clearing the way

Despite such positive trends and high hopes, the magnitude of reforms required in China, and the need to develop the PRC's human capital, meant that trade and investment grew slowly. Also, the strategic rationale behind the bilateral relationship remained fundamental for both Beijing and Washington. President Ronald Reagan set aside his visceral aversion to all things communist and supported expanded ties with China as a way to complicate matters for Soviet leaders. By the late 1980s, the cumulative effects of impro ved economic ties, substantial domestic reforms in the PRC, and an easing of Cold War tensions increased the momentum of US-China trade and investment activities.

In 1989, however, the bilateral political relationship, always an important factor in shaping economic ties, sustained serious damage. The events in Tiananmen Square in June severely frayed economic ties; the combination of moral revulsion in the United States and the resurgence of orthodox forces in the PRC quickly dealt a body blow to US trade with and investment in China. Further, the collapse of the Soviet empire during the last six months of 1989 virtually erased the strategic rationale for strong US-China political ties.

The changed political environment produced US sanctions against China, encouraged human rights and other activists to work with Congress to place MFN renewal in jeopardy each year, and made many US firms reticent when it came to defending strong economic ties with China in a hostile public arena. In addition, China's inflation-fighting policies threw the PRC domestic economy into recession, reducing both demand for American products and the ability to absorb US investment.

In sum, despite substantial hype at various points along the way, Sino-American business ties remained modest for two decades after President Nixon's pathbreaking trip to Beijing. Strategic and political factors contoured the economic relationship, and the diff iculties inherent in China's protracted effort to evolve toward a market economy limited successful business. During the 1980s, ethnic-Chinese entrepreneurs from Hong Kong and Southeast Asia, who tend to be more comfortable operating in an opaque market where personal ties and special favors count a great deal, proved far more adept than US firms at forging business ties with China. On the positive side, even taking the Tiananmen sanctions into account, the two governments made significant progress during these years in establishing the legal and policy frameworks necessary to develop substantial future business relations.

Full speed ahead

US-China business activities have expanded rapidly since 1993, achieving a size and maturity previously unmatched. Bilateral trade mushroomed to $75.3 billion in 1997, albeit with a US trade deficit that has reached politically sensitive dimensions. US direct investment in China has grown apace during 1994-97, totaling over $12 billion in utilized investment (see p.34). China has also begun to play a direct role in the US economy. The PRC government now is second only to Japan in holdings of American government debt instruments. And many Chinese firms have invested directly in American operations (see p.32).

An assessment of Sino-American business ties over the past 25 years thus must conclude that a strong foundation has been laid. Both trade and investment have reached substantial levels, and business relationships have matured. American products in China hold significant market share in sectors ranging from primary foods and consumer goods to information technology and aircraft. And American firms are among the leading foreign players gaining access to China's gradually opening service sector. A substan tial share of the products made in China by foreign-invested enterprises are competitive in a broad array of sectors in the United States. In 1997, roughly one-fifth of Chinese exports went to the American market, and 41 percent of PRC exports were produced by foreign-invested enterprises.

Many trends in the Chinese economy provide grounds for optimism about future growth in US business activities in the PRC. Current efforts to restructure the State-owned enterprise (SOE) sector and to put the banking system on a sound footing promise an immediate need for US consulting and investment banking services and, eventually, a more market-driven economy that should foster the type of competition in which US firms thrive. Long-term changes in China have tended toward greater openness, transparency, and predictability, all of which are favorable developments from a US perspective. And China's GDP is reaching a level at which significant consumer dollars are available for the purchase of foreign products.

Not smooth sailing, yet

• World Trade Organization (WTO) accession China's accession to the WTO will be important in several respects. While China and the United States both want to reach an agreement on the terms of China's entry, China will not gain membership over US objections. The two sides continue to disagree on the phase-in period for China's entry. The United States, viewing China as a highly successful export economy, is calling for full WTO compliance shortly after PRC accession. China, fearing overwhelming foreign competition in its home market, is arguing for a longer phase-in period. It will take political courage on both sides to hammer out a workable compromise. For the time being, failure to reach an agreement is being blamed squarely on the intransigence of the other side.

  But an accession agreement stands to generate enormous benefits for the bilateral relationship. It will provide a quantum leap in the predictability of future Chinese economic reforms, which, in turn, would considerably improve the PRC business climate. In addition, an accession agreement almost certainly will take the MFN renewal issue off the table, stabilizing the relationship.

  Yet the financial meltdown throughout much of East Asia, which started in the last half of 1997, may make an accession agreement between the United States and China more difficult to reach. WTO opponents in Beijing may argu e that much of the difficulty around Asia stems from the types of market opening that they oppose, including financial sector liberalization. Alternatively, reformers in China may seek to use WTO membership conditions as political cover to make the changes that they feel are necessary for China to become globally competitive over the long term. They may find it convenient to be able to blame the WTO for requiring such changes. Such a strategy already can be seen in economic reform politics in India.

• The US-China trade deficit The US-China trade deficit ballooned to $49.7 billion in 1997, second only to the US deficit with Japan. Though few economists are alarmed about this development--economists generally are reluctant to analyze trade in bilateral terms--politicians are deeply concerned. Devaluations in most of East Asia since the summer of 1997 have tilted trade balances throughout the region against the United States, potentially rubbing raw protectionist sentiment on both the American right (Buchananite Republicans) and the American left (Gephardt Democrats). If, under these circumstances, China should yield to the pressure to devalue the renminbi (RMB) to maintain export competitiveness, the political backlash in the United States could prove harmful to bilateral economic relations. Beijing, however, has taken care to maintain the value of the RMB, a stance applauded by the US government.

  But the bilateral deficit issue is likely to prove difficult to resolve. China is reluctant to use its hard currency reserves to increase imports for fear it may need to call on these reserves for other reasons, such as helping to support the Hong Kong dollar or straightening out its own banking s ystem. Further, China will need to maintain its export levels, since the PRC is already suffering from excess capacity and high inventories in the production of such items as bicycles, cars, televisions, and washing machines. In addition, China's exports to the United States currently far exceed its imports from the United States. Even if PRC imports were to grow in percentage terms more rapidly than exports, the US trade deficit with China likely would continue to expand.

• International agreements China's inconsistent implementation of international agreements also could remain a problem in US-China relations. The PRC political system has become more corrupt and less responsive to Beijing's dictates on economic and other issues, complicating implementation of such agreements. Beijing is still effective in carrying out policies designated by the top political leaders as high priority and accompanied by a clear understanding that those who fail to toe the line will be held accountable. China's efforts to protect intellectual property rights (IPR), for example, have improved considerably since early 1997. But in reality, the highest political leaders have full dockets. As a result, only a small array of trade and investment issues ever attracts the attention that IPR issues have garnered.

  China's failure to live up to international agreements inevitably stiffens the backs of US leaders who must decide how high to se t the bar for China's WTO membership and whether to accept China's promises, such as those to restrict exports of nuclear technology. A poor PRC record in implementing international agreements in the future may risk the imposition of debilitating new US sanctions, which of course would increase political friction.

• China's domestic economic performance As China's economy matures, US producers can expect sharper competition from PRC firms for market share in China. The characteristics of the PRC market will challenge the formulas for success developed by US companies in China to date. Although China's middle class is growing rapidly, it does not resemble the middle classes of the advanced industrial democracies. US firms will have to tailor their products to be both attractive and affordable for consumers whose incomes are low by American standards. The smartest US firms will use what they have learned in China to increase their competitiveness worldwide. Eventually, these companies will find Chinese firms--not just foreign-invested enterprises in China--competing in the US market.

  China's domestic economic performance may have other spin-off effects that challenge US-China business ties. Restructuring the State-owned sector and related financial reforms should provide opportunities in both the short and long terms for US firms. But these initiatives also create considerable short-term risks of economic dislocation , high unemployment, slowed growth, and increased corruption. The economic earthquake in much of Asia has also made these initiatives more difficult to pursue. The Asian financial crisis has decreased the foreign investment capital available for restructuring SOEs and has increased export competition for the output of China's township and village enterprises and private sector, which in turn has decreased profit margins and job growth. In general, slower growth in China would reduce demand for American products and services.

  China is entering a period with considerable potential for more social unrest, especially among workers. If the US trade deficit with China grows in the midst of increasing reports of crackdowns on worker protests in the PRC, US political obstacles to US-China trade will likely multiply. In this connection, the AFL-CIO argues that the US trade deficit with China is largely the result of China's lack of free trade unions. According to the AFL-CIO, if free trade unions were allowed in China, there would be no US-China trade deficit and many jobs would flow back to American workers. In reality, however, most of those jobs would more likely go to Vietnam and other emerging markets.

• American politics American politics could jeopardize the bilateral economic relationship. Ever since the 1989 Tiananmen incident, diverse American advocacy groups--for human rights, non-proliferation, the right to lif e, and fair trade, among other causes--have sought to link their agendas to alleged abuses in China, arguing that the PRC is the world's most notorious offender in each area. Although Chinese behavior in each of these areas is, to some extent, offensive to American values and/or law, the claim that China stands out among global offenders is generally spurious. China has received this unwelcome attention, rather, because the events in Tiananmen Square created a compellingly horrific set of images of the PRC that provides additional visibility, emotion, and fundraising capacity to any cause that can link its agenda to Chinese conditions.

  The potential danger that US politics can inflict on US-China economic relations is illustrated by the case of religion. The evangelical right, by focusing on Chinese treatment of Christians, is trying to wrench the Republican Party away from what it sees as an "amoral big business" agenda to a "morally based conservative values" one. Consequently, China is becoming a wedge issue in the fight for the soul of the Republican Party. The Christian Right's portrayal of this issue lacks sensitivity to changes in either China or overall US-China relations, and their political use of the China issue poses substantial potential danger for US business ties with the PRC.

Politics remains pre-eminent

Perhaps the most important accomplishment over the past 25 years is that the overall China-US relationship is now both broad and deep enough to weather trying times in any single area. But healthy US-China business ties will require ongoing attention to the political as well as the economic challenges for a long time to come.

Kenneth Lieberthal is the William Davidson Professor of International Business at the University of Michigan Business School. He is also professor of political science at the University of Michigan.