Statement of Terrence B. Stewart, Esq., Stewart and Stewart

A.        Introduction

Over the past 25 years, the U.S.-China trade relationship has grown to be an important one for both countries.  On the US side, China is now the US’ third largest trading partner, surpassing Japan in 2003.  In 2004, China was the second largest supplier of imports to the US (behind Canada) and the fifth largest purchaser of US exports (after Canada, Mexico, Japan, and the UK).  If current trends continue, China is likely to surpass Canada and become the US’s largest source of imports by 2006.  On the Chinese side, the US is China’s second largest trading partner overall, the number one destination for exports from China, and the sixth largest supplier of imports into China.

The most significant aspect of US-China trade, however, is that it is seriously imbalanced.  Since 1985, the US trade deficit with China has increased year by year.  In 2004, the deficit reached $162 billion, the largest bilateral trade deficit ever recorded.  See tables and chart below.

US-China Trade Balance US$ (billion)

Although China is currently the fastest growing export market for US goods, the much smaller US export base means the US runs an increasing trade deficit with China, with the result that the growth in US exports to China is dwarfed by the growth in US imports from China.

The ever-growing trade deficit with China is not sustainable.  The trade deficit flows from factors that are not market-driven, such as WTO compliance problems, currency issues, and intellectual property violations, among others.  The US needs to take forceful and effective action to shrink the trade deficit with China, to bring the trade flows between the US and China into a realistic balance, and to work to improve respect in China for the rule of law.

B.        Summary of Presentation

This paper is largely drawn from a report prepared for the U.S.-China Security and Economic Review Commission earlier this year and testimony provided to that body in February.  See www.uscc.gov/hearings/2005hearings/written_testimonies/05_02_3_4wrts/
stewart_terence_wrts.pdf.  The paper provides an overview of the major trade and economic issues in the US-China Relationship.  It reviews China’s WTO Compliance in its first three years of membership, then outlines the major trade remedies that the US should employ to insure more of a level playing field.  The paper then examines the increasingly important exchange rate issue.  Then it comments briefly on the range of IPR Protection issues.  And finally, the paper identifies some potential WTO cases that the US could bring in the WTO where China is having difficulties bringing itself into compliance and where a WTO challenge could be helpful in bringing about compliance in fact.

China has made tremendous strides in meeting its WTO obligations, but it still has a long way to go.  While not all parts of the government seem to be fully committed to full compliance, the efforts taken by China have been extensive and are generally viewed as a good faith effort to address the complex challenges China faces in changing its economy to be fully in compliance.  China has worked reasonably well on many issues in a bilateral fashion to address a number of problems, and the U.S. and other trading partners have worked hard to provide the technical assistance and other help to permit China to achieve what it appears to generally desire, a system in compliance.  Nonetheless, given the particularly problematic disparities in the bilateral US-China trade relationship it is critical that we use all tools available in the WTO and within our own trade laws to help China move toward meeting its obligations both to the US and to the world trade regime generally.

C.        Overview of China’s WTO Compliance

In 2004, the third year of China’s WTO membership, China met its WTO commitments in numerous areas.  Nevertheless, in many areas, China has still not achieved full compliance with its WTO commitments.  For example, in the following areas, the US Trade Representative’s 2004 WTO compliance report noted continuing concerns to both the US government and the US private sector.

• Intellectual property rights:  Although China has undertaken major efforts to revise its IPR laws and regulations, piracy remains rampant and enforcement of IP rights is seriously inadequate.
• Trading and distribution rights:  China implemented its commitment to full trading rights ahead of schedule.  However, concerns remained regarding distribution rights in that China had not issued specific rules clarifying how distribution rights would be acquired.
• Services:  In many services sectors, although China met the “letter” of its commitments to liberalize services, it frustrated the “spirit” by imposing new and burdensome licensing and operating requirements, such as high capital requirements and prudential rule requirements that exceeded international norms.
• Agriculture:  US exporters experienced continuing problems with market access and transparency.
• Industrial policies:  In a number of areas such as the following, China has continued to employ policies that effectively limit or impose conditions on market access, or give preferential treatment.

• discriminatory VAT policies
• failure to provide national treatment with respect to price controls on medicines and drug reimbursement
• preferential import duties to certain products (particularly from Russia)
• discriminatory application of SPS measures
• disparate standards testing of foreign products compared to domestic products
• inadequate transparency for proposed technical regulations and conformity assessment procedures
• development of unique standards for products in spite of existing international standards
• inconsistent application of the China Compulsory Certification (CCC) mark
• investment laws and regulations that continue to “encourage” technology transfer
• an auto industrial policy that discourages auto parts imports and encourages use of domestic technology
• government procurement policy that mandates purchases of Chinese-produced software to the extent possible

D.        Overview of Trade Remedies

When China acceded to the WTO in December 2001, its trade regime was not fully consistent with WTO rules.  As a condition of granting China early entry into the WTO, China agreed that, for certain periods of time following accession, other WTO Members would be able to employ two China-specific trade remedy measures to address imports from China causing market disruption or injury to another Member’s domestic industries.

1.         China Product-Specific Safeguard (Section 421)

Article 16 of China’s Protocol of Accession established a general “product-specific special safeguard” measure with respect to Chinese goods.  This measure permits WTO Members, for 12 years following China’s accession (i.e., December 11, 2013), to take action to curtail surges of imports of Chinese goods that cause or threaten to cause “market disruption” to a domestic industry producing similar goods.  This product-specific safeguard, unique to China, is applicable to any type of product (both industrial and agricultural goods).

In US law, the China product-specific safeguard was enacted as Section 421 of the Trade Act of 1974 (19 U.S.C. § 2451).  The rationale of Section 421 is that US industries should not lose jobs due to competition from Chinese imports at a time when China is adjusting to WTO obligations.  Congress indicated that the measure should be applied vigorously to address import surges from China, noting that "if the ITC makes an affirmative determination on market disruption, there would be a presumption in favor of providing relief."

The ITC has conducted only five Section 421 investigations so far: (1) pedestal actuators, (2) steel wire garment hangers, (3) brake drums and rotors, (4) ductile iron waterworks fittings (DIWF), and (5) innersprings.  The last active investigation was completed more than one year ago, in March 2004.  In three of the five investigations, although the ITC made an affirmative injury determination and recommended relief, the President chose to deny relief to the domestic industry.  Given this track record, and the strong lobbying by China to discourage the President from granting relief in these cases, domestic industries have been discouraged from filing new petitions.  Thus, Section 421, unfortunately, has been an ineffective trade remedy.  The expectations of its utility as a measure to provide relief to US industries injured from a surge in Chinese imports have not been realized.

2.         China Textile Safeguard

The China textile safeguard is authorized by paragraph 242 of the Working Party Report to China's WTO accession. That provision permits other WTO Members, until December 31, 2008, to impose a safeguard measure restraining Chinese textile imports if it is shown that they are “threatening to impede orderly development of trade in these products” due to “market disruption.”  In the US, the Committee to Implement Textile Agreements (“CITA”) administers the procedures for investigating petitions and imposing safeguards on Chinese textile imports.  If a safeguard measure is imposed, CITA may restrain Chinese exports in the safeguard product categories to 7.5 percent growth.

To date, the US textile industry has used the textile safeguard mechanism with mixed success.  Because CITA did not issue procedural rules until May 2003, the domestic industry did not file initial petitions until July 2003 and CITA did not impose the first textile safeguards on three product categories until December 23, 2003.  Thereafter, in June 2004, US sock producers filed a safeguard petition and CITA imposed a safeguard on October 29, 2004.

In October and November 2004, anticipating the end of global textile quotas on January 1, 2005, a domestic textile industry coalition filed a series of textile safeguard petitions covering a variety of products that were based on the “threat” of increased imports rather than actual increased imports.  When CITA accepted the new threat-based petitions, retailer and importer groups filed suit in the US CIT claiming that CITA lacked authority to consider petitions based upon threat alone and asking the court to enjoin CITA from granting relief.  On December 30, 2004, the CIT granted the motion for a preliminary injunction and issued an order enjoining CITA from proceeding on the threat-based safeguard requests during the pendency of the court action.  The CIT’s preliminary injunction is currently on appeal to the US Court of Appeals for the Federal Circuit.

Most recently, on April 4^th, CITA self-initiated China textile safeguard investigations on three product categories based on preliminary import data from the first quarter of 2005, and on April 6^th, a domestic industry coalition filed seven safeguard petitions covering fourteen products.  Thus, after a shaky start, the textile safeguard appears to be being used and at least initial cases suggest it may be effective within the parameters of the provisions.

3.         Antidumping Duty Law -- Under-Collection of Dumping Duties on Chinese Imports

The trade remedy of antidumping law applies to imports from China as well as other countries.  However, in recent years, it has become apparent that, due to significant undercollection of dumping duties by US Customs on Chinese products, US industries that successfully petitioned for antidumping duty relief from Chinese imports have not received the full benefits of antidumping duty orders to which they are entitled under US law.

US Customs and Border Protection Agency reported in its FY 2003 annual report on the Continued Dumping and Subsidy Offset Act (CDSOA) (March 2004) that it had failed to collect $130 million of antidumping and countervailing duties, $103 million of which related to antidumping duties on Chinese imports, such as crawfish, paint brushes, iron castings, roller bearings, silicon metal, brake rotors, garlic and honey.  While the reasons for the duty undercollection are multiple and complex, contributing causes include: (1) failure by importers to post adequate cash deposits or bonds on entries, (2) CBP allowing importers to post a continuous entry bond instead of requiring a single entry bond as required by a Treasury Decision, (3) CBP allowing importers to post continuous entry bonds that are too low to cover eventual dumping liability, (4) cash deposits posted on estimated duties are lower than finally-determined duties and the importer fails to pay the difference due to bankruptcy or disappearance, and (5) in the case of “new shipper” reviews, a “loophole” that allows importers to post a bond, rather than cash deposits, on estimated dumping duties. 

Although the CBP has proposed a series of reforms to address this problem (e.g., such as ensuring that surety bond companies can cover defaults, requiring different bonding requirements where continuous bonds are used, and closely monitoring continuous entry bonds), the CBP’s FY 2004 CDSOA Report showed that it had failed to collect $260 million in antidumping and countervailing duties in 2004, $224 million of which related to antidumping duties owed on Chinese imports.

The CDSOA annual reports have identified the magnitude of the undercollection problem which largely stems from Chinese product imports.  It is critical that the full amount of duties owed be collected.  Effective action by Congress, CBP, and Commerce are needed to ensure the proper functioning of US antidumping law with respect to Chinese products.

4.         Countervailing Duty Law -- Non-Application of CVD Law to Imports from China

Since 1984, the US Commerce Department has not applied countervailing duty law to non-market economy (NME) countries, such as China.  Commerce reasoned that subsidization is a market economy phenomenon and could not exist in an NME where “markets” do not exist.  As a result of this policy, US industries cannot petition for the imposition of countervailing duties when injured by reason of Chinese imports benefiting from government subsidies.

Commerce’s policy, however, is not required by statute.  Rather, it was established in an administrative determination and could be reversed or changed by administrative action.  Indeed, the US position is bizarre at the present time in light of the heavy emphasis the US placed on eliminating or limiting subsidies as part of China’s accession process to the WTO.  If subsidies cannot exist in China, why did the US insist time and time again that such subsidies had to be eliminated, reduced, identified and/or reported?

The US’ continuing concern over Chinese subsidies belies that premise of Commerce’s policy that subsidies cannot exist in a NME.  In the most recent Transitional Review Mechanism, the US inquired about or identified a large number of Chinese subsidy programs that appeared to constitute either prohibited or actionable subsidies under the WTO Agreement on Subsidies and Countervailing Measures.  For example, in one submission, the US asked:

• Semiconductors – whether China grants VAT rebates on semiconductor exports;
• Copper – whether China grants VAT rebates on imports of copper scrap or on exports of copper-based, semi-fabricated  or finished products;
• Subsidies to State-Owned Enterprises Running at a Loss – whether China has eliminated these subsidies as promised in the accession agreement;
• Non-Performing Loans – China’s injection of US$ 45 billion into the Bank of China and the China Construction Bank; China’s debt forgiveness as part of the Northeast Revitalization Programme;
• Price Controls – whether certain price control programs provide subsidies.

In another submission, the U.S. identified a number of programs and practices that appeared to constitute prohibited subsidies, as well as other programs that appeared to constitute actionable subsidies:

Subsidies Contingent Upon Export Performance

• Honourable Enterprises – preferential benefits
• Export-Contingent Tax Reduction for FIEs in Special Zones
• Income Tax Refund for Foreign Investors Investing in Export-Oriented Businesses
• Special Steel for Processing Exports Policy
• Export-Contingent Income Tax Reduction for FIEs or Tax Allowance for FIEs
• Export Subsidies for High-Technology Products
• Customs Duty and VAT Refund on Imported Capital Equipment Used for Production of Products for Exports
• Government Assistance to Increase Fabric Exports
• Tax Incentives for Dehydrated Garlic Exports
• Guangdong Grants Provided for Export Performance
• Low Interest Loans for Processors of Agricultural Products in Henan Province

Subsidies Contingent Upon the Use of Domestic Over Imported Goods

• VAT Rebate on Purchases of Domestic Equipment by FIEs
• Enterprise Income Tax Reduction for Purchase of Domestically Made Machinery and Equipment

Other Programs

• Assistance provided to Forest Products
• Assumption of Interest on Loans for Technology Upgrades
• Assistance for Capacity Expansion in the Soda Ash Industry
• Assistance provided to the Textile Industry
• Chendu Assistance to the Semiconductor Industry
• Reduction in VAT for Sino-Russian Border Trade
• Subsidies listed in Annex 5A of China’s Protocol of Accession

In sum, Commerce’s policy should be changed.  First, Congress could amend the countervailing duty law to expressly provide that CVD law applies to non-market economy countries.  A number of bills (H.R. 1216; S. 593) have been introduced in both the House and Senate to make such a change.  Second, Commerce has the discretion to change its present policy on its own.  Given that Commerce's policy is not required by statute, a change in policy would likely be upheld by the courts as long as Commerce supports the change with reasoned analysis.

E.        Exchange Rate Policy

For ten years, China has maintained a fixed exchange rate for their currency relative to the dollar (8.28 renminbi to the US dollar).  Despite urging by the US that China move toward a flexible, market-based exchange rate and indications both publicly and at senior levels that it would move to a flexible exchange rate, China has not yet done so.

Many economists estimate that China’s currency is undervalued by as much as 40% or more.  This means that Chinese goods compete domestically and internationally at prices that are artificially low, hurting US producers in the US market, in the Chinese market and in third country markets.  Moreover, it is argued that China’s pegged exchange rate effectively acts as a tax on US exports and a subsidy to China’s exports, which cause the loss of US manufacturing jobs.

A number of attempts have been made to address this problem.  For example, Senators Schumer and Graham’s bill (S. 295) would impose a 27.5% additional duty on Chinese imports unless the President certified to Congress that China was no longer manipulating its exchange rate and that its currency was at or near its fair market value.  In addition, two Section 301 petitions were filed in 2004 with the US Trade Representative seeking US action regarding China’s exchange rate policy, but USTR rejected both petitions.

Various bases for a WTO challenge to China’s exchange rate policy have been proposed.  The primary grounds for challenging China's exchange rate policy are that China's undervalued currency (1) constitutes a prohibited export subsidy within the meaning of GATT articles VI and XVI, and the WTO Agreements on Agriculture and Subsidies and Countervailing Measures, (2) violates GATT Article XV:4, and (3) violates China’s obligations under the International Monetary Fund’s Articles of Agreement.  However, while these potential grounds have prima facie merit, it is unlikely that this Administration, which rejected similar arguments in the Section 301 petitions, would initiate a WTO challenge on these grounds.

Separately, another potential way to address the exchange rate problem would be to modify US antidumping law and/or countervailing duty law to permit currency manipulation to be treated as a form of dumping or subsidization consistent with the original GATT notes.  This approach is reflected in the recently introduced Ryan/Duncan bill (H.R. 1498).

F.         Intellectual Property Rights Protection

How to protect intellectual property rights (IPR) is one of the most serious issues facing US companies vis-à-vis China.  Notwithstanding China’s efforts to improve its IP legal regime to comply with WTO obligations, China’s IPR enforcement system is far from adequate.  The problem of intellectual property piracy and counterfeiting is endemic in China and has caused a tremendous adverse impact on US businesses.  The rate of piracy is enormous, estimated to be about 90 percent over the last 15 years for certain types of products.  USTR’s 2004 WTO compliance report notes that “current estimates of US losses due to the piracy of copyrighted materials alone range between $2.5 billion and $3.8 billion annually.”  The World Customs Organization has estimated that global counterfeiting amounts to more than $500 billion annually with the majority of that originating in China.  See Fakes!, Business Week, February 7, 2005.

At the JCCT meeting of April 2004, where the IPR issue was made one of the highest priorities, the US secured a commitment from China’s Vice Premier Wu Yi that China would undertake a series of actions to significantly reduce IPR infringement throughout the country.  In December 2004, as it pledged at the JCCT meeting, China issued a long-awaited judicial interpretation (Judicial Interpretations on Several Issues Regarding Application of Law in Criminal Intellectual Property Rights Cases) that was expected to bolster China’s IP criminal enforcement abilities and efforts.  Many observers, however, view the new interpretation as inadequate because, among other things, it maintains thresholds which offer loopholes for potential counterfeiters.

In USTR’s special 301 out-of-cycle review on China’s IPR enforcement efforts, comments by industry groups and private sector organizations show that IPR violations abound in virtually all industries.  It is urgently necessary that China address its many IPR enforcement shortfalls, including lack of deterrent penalties, lack of transparency, insufficient resources for police investigations, reluctance to enforce IPR by regional governments, etc.

The US should continue to emphasize the importance of improving IPR enforcement and should work with other WTO Members (e.g., EC, Japan, and others) to provide China with effective training and technical assistance and to coordinate increased pressure on China to make the legal modifications necessary to improve IPR enforcement.  Should these efforts not prove effective, the US should then consider the possibility of WTO dispute settlement.

G.        Potential WTO Cases

China has now been a WTO member for three years.  USTR has noted that while China has made impressive efforts to fulfill its WTO commitments, China’s actions to fulfill its commitments are far from complete and have not always been satisfactory.  So far, only one WTO dispute settlement case has been filed against China – in March 2004, the US filed a case concerning China’s discriminatory VAT policies.

After three years, however, the US should give serious consideration to filing dispute settlement cases at the WTO on a number of outstanding issues where China is not fully in compliance with its commitments.  If used prudently, WTO dispute settlement cases would be a means to induce and encourage China to come into full compliance with its WTO commitments.

Based on USTR’s 2004 compliance report, and to the extent they remain unresolved, there are a number of potential areas where China’s non-compliance could be considered as potential topics for WTO dispute settlement cases, such as the following:

• Customs Valuation:  US exporters are still encountering valuation problems at Chinese ports.  These problems include:  (1) valuation based on reference pricing instead of transaction value; (2) addition of royalties and license fees to the dutiable value of imported software; (3) non-uniform valuation by ports of particular digital products; and (4) valuation of high-value electronic media to be used to produce multiple copies of products (e.g., DVDs) based on the estimated value of the future copies instead of the value of the carrier medium itself.
• Export Quotas on Fluorspar:  China has continued to impose export restrictions on fluorspar.  China imposes quotas and license fees on fluorspar exports, but does not restrict domestic users of fluorspar.
• Nondiscrimination:  US pharmaceutical manufacturers have experienced national treatment problems regarding price controls on medicines and drug reimbursement.  China has continued to discriminate in applying SPS measures.  With respect to fertilizer, China exempts all phosphate fertilizers except DAP (a fertilizer the US exports to China) from a 13% VAT.  So far, China has not changed this policy.
• Consumption Taxes:  The effective consumption tax rate on imported products (e.g., spirits/alcoholic beverages, tobacco, cosmetics and skin/hair care preparations, jewelry, fireworks, rubber, motorcycles and automobiles) is substantially higher than the rate applied to domestic products because China uses different tax bases to compute consumption taxes for domestic and imported products.
• Standards Testing:  Despite China’s changes to its standards testing regime, in some sectors, foreign products are tested in specially designated laboratories that are separate from those laboratories used to test domestic products.  Disparate testing can lead to uneven treatment.
• Conformity Assessment Procedures:  Despite national treatment commitments, to date, China has accredited 68 Chinese enterprises to test for and certify the CCC mark, but has not accredited any foreign-invested conformity assessment bodies.
• Auto Industrial Policy:  The new auto industrial policy contains discriminatory provisions that discourage the importation of auto parts and encourage the use of domestic technology.
• Sanitary and Phytosanitary:  Regarding raw poultry and meat, China applies certain non-science-based standards (e.g., zero tolerance for pathogens) to imports that are not applied to domestic raw poultry and meat.  This violates national treatment and has slowed imports from the U.S.  Regarding food additives, China imposes overly restrictive standards that block imports of many US processed food products.
• Financial Services – Insurance:  China has been issuing concurrent branch approvals (more than one at a time) for Chinese insurers, but only approving branches of foreign firms consecutively (one at a time).
• Express Delivery Services:  In July-November 2003, China circulated draft amendments to the postal services law, which (1) gave China Post a monopoly on letters under 500 grams (a horizontal commitment violation as it restricted existing scope of activities), and (2) failed to establish an independent regulator.  At the April 2004 JCCT, China indicated that the weight restriction would not resurface as a problem.  However, the July 2004 draft amendment still contained a weight restriction (reduced to 350 grams).