U.S. and China Still Must Resolve Key Trade Issues

Last week’s U.S.-China presidential meeting produced no breakthroughs on sensitive trade issues, and analysts say that could mean the two countries are heading into rough waters in the months ahead.

Though President Bush and Chinese President Hu Jintao pledged to work together to resolve their economic differences, both leaders face domestic pressures that will make it difficult to find common ground, particularly on the U.S. demand that China adopt a flexible market-based currency.

The leaders sought to downplay their differences in public, emphasizing their efforts to cooperate on issues that extend far beyond economics, such as North Korea’s nuclear ambitions. U.S. officials also pointed out that China had recently placed orders for $16 billion worth of U.S. airplanes, farm goods and computer software and had taken some steps to address the trade irritants.

Indeed, during his four-day visit to the U.S., Hu surrounded himself with American business leaders, a strategy aimed at winning support from firms that have invested heavily in China and also are influential in Washington and on Wall Street.

Over the weekend, People’s Daily, the Chinese government’s mouthpiece, touted Hu’s visit with Microsoft’s Bill Gates at his home as particularly significant. Only days before Hu’s U.S. trip, Beijing required all personal computers made in China to be installed with licensed operating system software, and three of China’s leading computer makers announced plans to buy Microsoft software licenses valued at $1.4 billion over the next three years.

But Robert Kapp, a China consultant and former head of the U.S.-China Business Council, said the presidential meeting, while “friendly and respectful,” failed to deliver concrete examples of the two countries “clearly and visibly working together to build a stronger world.” He said evidence of cooperation on issues such as environmental protection or global health would help citizens understand the broader importance of the relationship.

The coming months will be tough for the Bush administration, which is heading into mid-term elections and the prospect of a trade deficit with China as high as $250 billion by year-end. Lawmakers have threatened to place tariffs on Chinese imports or restrict U.S. government-backed loans to China unless Beijing takes more aggressive action on currency reform. U.S. manufacturers say the Chinese yuan is undervalued by as much as 40%, giving its exporters an unfair advantage.

Hu held firm to his government’s go-slow position in Washington, though he said his government would continue to make efforts to improve its exchange rate. Chinese officials fear that rapid currency appreciation would invite speculators, trigger an outflow of funds and hurt export industries that provide badly needed jobs.

Last July, the government widened the band in which the currency is allowed to trade, and the yuan has risen 1.2% since. But the currency weakened again Friday, after the presidential visit failed to deliver any promises from Beijing.

Economists say they expect the yuan to rise an additional 3.5% over the remainder of this year, but that is unlikely to placate critics in Congress and in U.S. manufacturing sectors such as textiles and apparel, who have been the leading critics of China’s currency policies.

What’s more, analysts said Hu’s pledge to steer China’s economy away from its dependence on exports and investments to greater reliance on private domestic consumption would take time. While China’s economic output is expanding at an impressive annual pace of 10%, the vast country is grappling with a mass migration of rural workers into the cities. Some economists estimate there may be a surplus rural workforce of 130 million.

Zuo Xiaolei, chief analyst at China Galaxy Securities in Beijing, thinks it will be at least five years before rural employment and incomes grow strongly enough to stimulate domestic consumption. “We have to create jobs for these people, and the best outlet is manufacturing with large scale,” she said.

Frank Vargo, vice president of the National Assn. of Manufacturers in Washington, a leading critic of China’s currency policies, said he was disappointed by Hu’s failure to deliver more substantial promises of change. His organization has urged the Treasury Department to label China a “currency manipulator” in a report due out soon. If that happens, the U.S. will be required to start negotiations with Beijing to address the problem.

The Bush administration has urged China to become a “more responsible stakeholder” in the international economy. Deputy Secretary of State Robert Zoellick, the administration’s major China policy architect, said recently that the U.S. intended to push China harder to reduce government intervention in the economy, such as the subsidies provided to the steel industry.

But such shifts in policy will be difficult for Beijing to implement because many local governments operate autonomously and are competing with one another to build powerful industrial specialties that will drive jobs and tax revenue.

Some of the toughest issues are likely to land in the lap of the World Trade Organization. The U.S. and the European Union asked the WTO last month to look into China’s taxes on imported auto parts. The U.S. also has said it may file a complaint over China’s lax enforcement of intellectual property rights if that situation fails to improve.

But the WTO is distracted by its own set of problems, led by the breakdown in talks on a new round of reductions in global trade barriers. Trade experts said last week’s decision by the Bush administration to replace its top trade negotiator bodes ill for the faltering trade talks, sending a message that the U.S. was shifting its attention to domestic issues. U.S. Trade Representative Rob Portman is moving to the Office of Management and Budget and will be replaced by Susan Schwab, a veteran trade official who was his deputy.

Jack Perkowski, the Beijing-based head of Asimco, which has invested hundreds of millions of dollars in auto parts and other businesses in China, doesn’t think the WTO complaint on auto parts will “make a whole lot of difference” anyway. He said Chinese factories were so much more efficient, and lower cost, that they would still win the orders even if the tax on imported parts was removed.

Iritani reported from Los Angeles and Lee from Shanghai.