Trade and Investment with China
— And Some Implications for the United States and Hong Kong
Consul General Kurt Tong
Foreign Correspondents’ Club, Hong Kong
April 24, 2018
Good afternoon, ladies and gentlemen, and a special thank you to the Foreign Correspondents Club for inviting me back today.
The last time I spoke here I focused on Hong Kong, and its unique governance challenges and opportunities under the “one country, two systems” framework. Today, I would like to expand the scope of discussion to include Mainland China, and focus specifically on economic issues.
To be more specific: Today I would like to discuss a problem that I consider to be one of the most important trade and investment policy challenges that the entire world faces today — China’s slowness in adopting global norms and best practices for market-based trade and investment transactions.
As you might imagine, I have gotten a lot of questions from friends in Hong Kong about the U.S. approach to this matter. So today seems like a good opportunity to explain how the United States government views trade and investment with China, and our goals going forward.
And given that we all live in Hong Kong — and we all love Hong Kong — I will also touch upon how I see the implications of all these issues for this wonderful city, which continues to be a dynamic bastion of free market economics in the Pacific region.
So, let me start with the United States, and then turn to China, before concluding with some thoughts on Hong Kong.
The United States Values Free and Open Trade
Perhaps a little personal history is in order. Before moving to Hong Kong two years ago, I spent much of my three decades as a diplomat focusing on the promotion of “free and open” trade and investment in the Indo-Pacific region. I was in the room when we decided to negotiate a free trade agreement with Korea, and I was there again when we mapped out the Trans-Pacific Partnership. And I chaired the APEC meetings in 2011 when we collectively took giant steps toward eliminating barriers to trade in environmental goods and information technology, first regionally and then worldwide.
For my entire career, and for many decades before that, America’s commitment to free and fair trade has been second to none.
I am confident that this has not changed. In fact, America’s commitment to defending an open and fair global trading system may in some ways be stronger than ever, even as we adapt to new challenges.
Let’s review some important facts: In 2017, the United States was once again the top trading nation in the world, exporting and importing more than $5 trillion in goods and services, or roughly one-quarter of the total value of our economy. According to the Heritage Foundation, our average applied tariff rate was just 1.6 percent last year.
This openness is reflected in our history of economic diplomacy as well. The United States was the driving force behind the creation of the General Agreement on Tariffs and Trade in 1948, as well as the World Trade Organization after that, in 1995. We are now a member of 14 bilateral and regional free trade agreements, including the world’s largest such group, the North America Free Trade Agreement. The United States led the negotiations that resulted in China’s admission to the WTO in 2001.
Given our steadfast dedication to free market principles, I think it is clear that the United States will continue to be a leading player in the world economy, even as other partners grow. The size of our economy totaled more than $19 trillion in 2017. That figure is not only the top spot, but it represents nearly one-quarter of the global economy, even though it was produced by only 4% of the world’s workers.
Perhaps most important for the future, the United States economy is still expanding and improving, recently growing at a brisk pace of about 3% per year. This strong domestic growth means that America is continuing to make a big contribution to global growth, through import demand of course, but also through outward investment — another area where we lead the global rankings.
To be sure, the United States has its share of domestic economic challenges, including aging transport infrastructure in some regions. We also need to revamp our education system to meet the demands of rapid advances in information technology. But it is important to remember that the United States continues to drive and energize global growth by being the most innovative economy in the world.
According to the most recent World Economic Forum (WEF) Global Competitiveness Index, the United States is now the second most competitive economy in the world, right behind Switzerland.
In fact, 49 of the 100 firms on the 2017 Forbes list of the World’s Most Innovative Companies are from the United States. If you don’t trust Forbes, 36 of the companies on Clarivate Analytics’ list of the Top 100 Global Innovators in 2017 were also from the United States. American innovation touches every industry, and you can see pretty much everywhere the common theme that U.S. companies are the ones at the forefront of developing and deploying disruptive new technologies, as they work to deliver value to their customers.
But beyond all that bragging, here is the key point: The United States economy achieved its strong economic position by liberating the creativity of our people, and that of our partners, by using transparent, fair, and democratic processes to tackle problems, both large and small. That market-based creative process has worked well — from building out our highway system, to cleaning our environment, to creating the world’s most productive agricultural system, to creating and then revolutionizing global energy production, to developing the digital economy.
And we have shared our resulting prosperity with the rest of the world, through trade, and through investment.
I think that China and Hong Kong understand well the prosperity that trade with America brings. Indeed, the United States is inextricably linked with China’s current economic success.
American companies have contributed expertise and capital to China’s development for decades, and the United States remains China’s top single-nation trading partner. It takes entire economic “communities” — the entire European Union, for example, or all of ASEAN — to match the value of the U.S. market for China’s international trade.
U.S. foreign direct investment in China, meanwhile, totaled $93 billion in 2016, up 10% percent over the previous year, led by manufacturing, wholesale trade and non-bank holding companies.
As for Hong Kong, the United States is this city’s largest trading partner beyond the Mainland, and its fifth-largest supplier of imported goods, overall. Two-way trade in goods and services has now reached close to $70 billion each year, and it is still growing.
And Hong Kong also remains an important entrepôt for merchandise flowing between the United States and China. In 2016 approximately 9% of China’s exports to the United States, and 7% of China’s imports from the United States, passed through Hong Kong.
So maintaining a healthy U.S.-China trade and investment relationship is clearly important to Hong Kong, as well.
The Problem with China
Which brings me to the issue of the day. Amid all that good news that I just relayed, about trade among nations creating greater prosperity, why is the United States now calling “foul” and demanding that China change its ways?
Or to re-frame the question more positively, what can Mainland China do to truly open its economy? What can China do to be a better and fairer trading partner for the other economies of the world?
China’s undeniable path of reform and opening over the past 40 years, starting from a position of almost complete economic repression, was certainly visionary, and it led directly to the prosperity we see in China today. I can understand why leaders such as Deng Xiaoping and Zhu Rongji are so revered in China for pushing forward a process of change.
However, the work that they started is far from finished.
Perhaps most worrisome, actually, is the sense that we have in the United States that China’s forward progress on economic reform and opening in recent years has stalled. In fact, depending on the issue under consideration, there are some worrisome signs that things may be moving backward.
China is the world’s second largest economy — and largest outright if weighted to the purchasing power of its population.
But China is not yet a true market economy. China ranks 110th on the Heritage Foundation Index of Economic Freedom, for example, reflecting extensive state ownership and far-reaching state intervention.
Recently, in fact, the nation appears poised to move in the direction of putting the Communist Party at the center of all important economic and social decisions — including previously private business decisions — even as it has doubled down on central government control and planning, and state-ordered investment.
China’s pure size, and international economic success, has fostered the idea, as expressed by some people, that it is okay for China to ignore global rules. Some thought leaders in China are even championing the narrative that a non-transparent, state-dominated approach to running an economy is a legitimate alternative to free and fair markets.
America, meanwhile, is left to worry that China may just want to pick and choose which global rules and norms it will follow, and which ones it will not.
For the United States, the result of this situation is growing disappointment. The U.S.-China trade and investment relationship, which should by now, based on scale alone, be one of the closest and most mutually beneficial in history, is instead quite badly skewed, and not really as productive for either side as it should be.
In 2017, the United States recorded a record-large $375 billion deficit in our trade in goods with China.
Of course, macroeconomic factors can explain some of this imbalance. American consumers have a high propensity to borrow and spend, while Chinese citizens are incentivized to keep their precautionary savings in domestic, low-return instruments, or risky real estate — meaning that they are stuck in a situation that former British Financial Services Authority Chairman Adair Turner last week at the Asia Society called a system of “forced savings,” reminiscent of Japan and Korea in an earlier era.
But beyond macroeconomic factors, microeconomic factors are certainly also a major part of the measured imbalances — and certainly microeconomic factors are the key elements fueling the increasing friction between China and all its foreign economic partners.
Take, for example, the situation with regard to inward foreign investment. Of the 180 economies worldwide assessed by the Heritage Foundation, only 13 score as more closed to foreign investment than Mainland China — a fraternity that includes nations such as Sudan, Eritrea, and Cuba.
Some might counter this assessment by saying, “China actually attracts a lot of inward investment.” And indeed, yes it does. But China has seen significant inward investment because many companies have essentially calculated that they have no choice but to invest in China, no matter how unfavorable the terms, because of China’s pure size and the importance of the Chinese market.
A recent report from the National Committee on U.S.-China Relations indirectly illustrates this situation. Looking at the data in that report, one sees that U.S. investment in China is predominantly concentrated in job-creating “greenfield” investment, whereas China’s rapidly expanding investment in the United States is almost all mergers and acquisitions, buying existing U.S. companies. Mergers and acquisitions are exactly the sort of inward foreign investment that is extraordinarily difficult to accomplish in China.
The current differences between China and the United States in economic policy are too extensive to mention in detail in any speech, but please consider these highlights:
- America’s Internet permits a free flow of ideas, goods, and services. China’s does not.
- U.S. tariffs, including on key products such as cars, are low. China’s average applied tariff rate is three times as high as that of the United States.
- The United States has strong protections for intellectual property rights. China does not.
I could of course go on. But what it all comes down to is that China’s WTO commitments reflect somewhat of a broken contract.
And from the perspective of the United States, the breaches in that contract are now sufficiently serious, and detrimental to the United States, that we are now justified in claiming damages.
The U.S. Trade Representative has done considerable research on these issues, so I think it is useful to consider the bill of particulars that is associated with the United States’ recent announcement that it may, in addition to suing China in the WTO together with other like-minded nations, take additional actions that respond to China’s unfair policies and practices under Section 301 of the Trade Act of 1974.
The focus of Americas’ protests are the Chinese government’s actions related to technology transfer, intellectual property, and innovation, which the Section 301 report notes are “unreasonable or discriminatory and burden or restrict U.S. commerce.” Those measures include:
- Joint venture requirements, foreign investment restrictions, and administrative review and licensing processes to force or pressure technology transfers from American companies;
- Discriminatory licensing processes to transfer technologies from U.S. companies to Chinese companies;
- Directing and facilitating investments and acquisitions which generate large-scale technology transfer; and
- Cyber intrusions into U.S. computer networks to gain access to valuable business information.
The evidence in support of these claims is documented in USTR’s 180-page report, which is available online for you to download — for free of course!
But in sum, to keep things simple, the core problem is this: China’s market-distorting policies and practices constrict the free market and directly harm the interests of all its trading partners — particularly the United States. This is especially vexing now that China’s technological capability in some areas is approaching global-best levels, making it much harder for China to justify its actions on the grounds of being a “developing country.”
I worry, in fact, that there is a deeper problem — which is that China’s recent policies may be based on the false premise that it was central control of the economy that got China to this point. Americans believe that it was not central planning, but rather China’s emerging pro-market and pro-investment policies, supplemented by access to the largest free markets in the world, that helped to write China’s impressive growth story.
In a nutshell, our hope is that China will double down on reform and opening, and boldly accelerate its embracing of global norms and world-wide best practices.
Trade Friction Can Be Useful
So, then, I imagine you are curious as to how I think this all might play out in the world of bilateral and multilateral economic diplomacy, over the coming months and years.
Many tons of journalistic ink has already been spilled on such speculation, and I don’t want to add too much more fodder to that cottage industry.
But let me just say this. Some analysts have said that, given its size and importance, China is now too big to be challenged. I would submit that the opposite is true. I think that the China problem is too big to ignore.
As I think I have demonstrated, recent U.S. decisions aimed at pressing China to raise its game on reform and opening, even at some risk to our own domestic markets and economy, are well-grounded in international law and WTO principles. America’s forcefulness in registering its complaints is well-justified by the facts — and perhaps it is overdue. But at any rate, the right time to start is now.
To borrow a metaphor from my favorite sport, China has drawn a deserved yellow card. Yellow cards are an opportunity for a player to change their style of play before someone gets hurt.
Sticking to that same metaphor, some might object to the idea of the United States appointing itself to be the match referee. But I would respond that as the leading custodian of the integrity of the global trading system — of the WTO and of international trade rules — the United States has no other option. Allowing China to systematically play outside the rules could only lead to even bigger problems in the future.
It is important to note that other WTO partners are lodging many of the same complaints. And the international business community has also been very supportive of the United States’ efforts to highlight our concerns.
In the end, of course, this is not a zero sum game. We all still have an opportunity to create a “virtuous cycle” — of redoubled global efforts to support market-based approaches and open borders.
China has a chance to accelerate its reform and opening, at a scale and pace that befits its influence in the global economy.
And it is important to remember that even China’s economists admit that the kinds of steps that the United States is calling for will actually make the Chinese economy stronger, and more resilient, over the long term.
We do not want the Chinese economy to fail. That would be terrible for the United States. We just want China to change — and to live up to the many commitments it has made under the WTO and in bilateral negotiations with the United States.
I think that that is the “win-win” outcome that everyone wants, and which is entirely achievable, given sufficient effort.
Hong Kong Has a Positive Role to Play
So let me wrap up today by turning to the implications of this situation for Hong Kong.
I know that U.S.-China trade friction has created some nervousness here in Hong Kong, which is part of China, yet a separate customs jurisdiction under “one country, two systems.”
I noted earlier that a significant share of the physical goods traded between the United States and China pass through Hong Kong’s ports. And in the non-physical sphere, an even greater share of U.S.-China investment flows, and services transactions, and financial transactions, utilize Hong Kong’s state-of-the-art financial markets, and its world-class lawyers, bankers and accountants, to lubricate U.S.-China economic transactions.
So a degree of nervousness is understandable. In fact, one Hong Kong friend told me that he was worried that Hong Kong will become a “voiceless victim” as Beijing and Washington take steps to work out their differences on international economic policy.
I do not expect that to happen.
In fact, I think that the current situation presents a real opportunity for Hong Kong to demonstrate its lasting value, as a transformative portal linking China and the rest of the world economy.
Hong Kong, in fact, is the visible proof that an economy can be part of China, but also be consistent with global best practices — with everyone making plenty of money and achieving prosperity; with everyone realizing “win-win” economic solutions without a lot of state intervention; and with government authorities respecting private property and the right of investors to make free decisions in a transparent system.
This is possible because of Hong Kong’s rules-based approach to commerce and regulation, and its fiercely independent judiciary, and its freedom of expression and of the Internet, and its highly liberal trade and investment and tax policies.
Let’s go back to that Heritage Foundation Economic Freedom Index I mentioned earlier. Hong Kong, famously, keeps being scored as the world’s No. 1, its most free economy, year after year. That is an amazing track record. And what about that WEF Global Competitiveness Index I mentioned, where the United States came in as No. 2? Hong Kong ranks an impressive sixth place overall.
Clearly, these facts are connected. Clearly, Hong Kong is competitive precisely because it is free.
This conclusion points toward what, I hope, will be Hong Kong’s role as the United States and China work forward to a better future by re-shaping our economic relationship.
My hope is that Hong Kong will make full use of what I call its “demonstration power” — its power to show just how much prosperity is possible when global best practices are applied, in China as they are elsewhere.
I have sometimes referred to the maintenance of Hong Kong’s high degree of autonomy under the “one country, two systems” framework as a “use it or lose it” proposition.
In this period of dynamic change, I think that Hong Kong has an opportunity to proactively use its autonomy, to further strengthen its impressive economic competitiveness, as well as its inherent value proposition in the eyes of foreign partners.
The Hong Kong private sector can do this by continuing to make good deals with counterparts from the United States, China, and elsewhere — making full use of the city’s strengths, as reflected in Hong Kong’s rule-of-law and core values.
The Hong Kong government can do this by energetically embracing, and sharing, this city’s abiding strengths. For example, the government could try to find ways to demonstrate even more strongly its commitment to protecting intellectual property, and to following global best practices for Internet government, data privacy and cross-border data flows. Regarding trade policy, the Hong Kong government’s free trade agreement with ASEAN and the agreement under negotiation with Australia are admirable examples of a creative and outward-thinking approach. Maybe Hong Kong should use this juncture to think outside the box and be even bolder in demonstrating its commitment to open markets, for instance by joining additional international trading arrangements, or hosting high-level APEC meetings, or hosting another WTO ministerial meeting. (My guess is that this time no one would try to swim across the harbor!)
Let me close with a historical reference.
This year we are celebrating the 175th anniversary of the U.S. diplomatic presence in Hong Kong. When our first Consul General started work here in 1843, his goal was to promote commerce between the United States and China. Later, at the turn of the century, the United States enunciated the Open Door policy, aimed at further expanding trade with China, while pushing the European powers to play fair. Throughout the 20th Century, the U.S. commercial presence in Hong Kong steadily expanded, always with an eye on the Chinese market.
The more thing change, the more they stay the same.
The United States is still here in Hong Kong, still working to open doors to free and open trade and investment, and still believing that Hong Kong is an outstanding platform for promoting trade and investment between China and America, to the benefit of everyone involved.
Thank you for your attention, and I look forward to your questions.