House Armed Services Committee Hearing
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INTRODUCTION
While 2013 has been a year of leadership change for China, it is too early to say that the initial economic policy pronouncements will lead to quick reforms. Less heralded but longstanding and continuing improvements in China's military capabilities, however, could have a major impact on the region.
The Chinese leadership accomplished a peaceful turnover during the past year, complicated by factional political maneuvering. The handoff for the new five-year term took place with both ceremony and caution. In the absence of immediate policy changes from the newcomers, the government in
The Chinese renminbi continued to appreciate against the dollar but remains undervalued. The rise in the Chinese currency did not jeopardize China's expanding trade surplus with
Also troublesome were the press reports in
U.S. companies investing in
After announcing with some fanfare a free trade zone in
One positive development in bilateral trade has been agriculture, the only sector in which
Under its new political leadership, China's actions in the East and South China Seas continued to increase tensions in the region. It is becoming clear China does not intend to resolve its maritime disputes through multilateral negotiations or the application of international laws and adjudicative processes but prefers to use its growing power in support of coercive tactics that pressure its neighbors to concede China's claims.
Since the Commission's 2012 Report, strong evidence has emerged that the Chinese government is directing and executing a large-scale cyber espionage campaign against
Meanwhile, China continued to develop and field advanced military platforms and weapon systems. China's comprehensive military modernization is altering the balance of power in the
China in 2013 expanded and diversified its arsenal of weapon systems capable of placing U.S. ships, aircraft, and bases in the
Furthermore, the PLA enhanced its regional power projection capabilities, improving
Most Asian countries welcomed the U.S. rebalance to
The Commission's Report addresses these and other issues in depth as it continues to monitor the evolving economic and security relationship between our two countries.
EXECUTIVE SUMMARY (USCC 2013 Report to
Chapter 1: The U.S.-China Trade and Economic Relationship
Trade and Economics Year in Review
China's economy grew at a 7.66 percent annualized rate in the first three quarters of 2013, continuing a three-year trend of decelerating output. This marked a significant decline from the three decades of growth in the 1980s, 1990s, and 2000s averaging 10 percent annually. Demand for China's exports stalled, and the domestic economy adjusted to a drop in government spending on massive infrastructure projects--undermining the two main pillars of China's economic surge over the previous decade.
China underwent a leadership change with a new president and premier and several new members of the
Growing demand from China has supported exporters in certain sectors of the U.S. economy, such as aerospace, the auto industry, and agricultural products. However, the U.S. trade deficit with China continues to widen. In
China continues to intervene in foreign exchange markets to keep its currency undervalued. Such interventions, combined with China's subsidies to exporting industries, have helped China accumulate the world's largest foreign currency reserves--
Trends in
China has amassed the world's largest trove of dollar-denominated assets. Although the true composition of China's foreign exchange reserves, valued at
The 12th Five-Year Plan (2011-2016) called for a three-pronged approach for increasing China's investment abroad. First, Chinese manufacturing companies should invest overseas in order to establish international networks and globally recognized brands. Second, Chinese companies should invest in research and development outside of China. Lastly, the plan set goals for shifting acquisitions toward sectors that promote a high-tech economy. This policy focused on investment goals in which domestic state-owned or state-controlled firms were already intended to be dominant by policy. These sectors included energy, machinery, construction, and information technology. The Chinese government wields many tools to drive these goals, including requiring permission for overseas investments by Chinese firms.
Despite China's large holdings of portfolio investment, China's FDI is still relatively modest. According to the
State-owned enterprises (SOEs) have dominated Chinese FDI in
Trade-related aspects of foreign investments often intersect with national security concerns. For example, foreign intelligence collection efforts and espionage that target U.S. technology, intellectual property, trade secrets, and other proprietary information can be concealed under the pretext of foreign investment in cleared government contractors.
Governance and Accountability in China's Financial System
China's 12th Five-Year Plan calls for less dependence on exports and state-funded infrastructure projects and more domestic consumption to support China's economy. A shift from government-led to private-led growth requires that Chinese families and private sector businesses have sufficient access to credit and capital. Bank lending, the traditional source of credit for entrepreneurs and startups in most countries, is largely inaccessible to Chinese individuals and small- to medium-sized enterprises (SMEs), because China's financial system is dominated by large, state-owned banks that mainly service government-directed projects.
Banks hold a unique position in
A ''shadow banking system'' of unofficial credit has sprung up to fill the gaps left by the big banks' lending practices. China's shadow banking system can broadly be defined as lending that falls outside of the official banking system. It can involve both traditional and nontraditional institutions and is best understood not in terms of the institutions engaged in the system but in terms of the activities that they undertake. Because shadow banking activity occurs outside of formal banking channels, it does not appear on bank balance sheets and is far less transparent than official lending activity. Chinese demand for shadow banking is largely driven by the growth of China's private sector, a sector with limited access to official bank credit; and the Chinese government's tolerance of shadow banking in recent years has been tied to the reality that the private sector is the increasingly dominant source of the nation's employment.
Demand for credit has led Chinese companies to seek capital overseas even as its shadow banking system has expanded. In the late 1990s, Chinese companies began raising capital on major international stock exchanges. This trend has been driven by large Chinese companies, many state owned, that have sought to broaden their shareholder base, increase the liquidity of their shares, and enhance the visibility of their brand names. U.S. stock markets are among the most popular global exchange destinations for Chinese firms.
Initially, U.S. investors purchased stock in U.S.-listed Chinese companies in hopes of profiting from China's rapid growth rate. However, investors in U.S.-listed Chinese companies have increasingly found that insufficient corporate governance standards make these companies high-risk investments. Many have been implicated in frauds and accounting scandals, and U.S. regulators have deregistered about 50 Chinese companies in the past two years following fraud probes. During recent probes, the
In
China's Agriculture Policy, Food Regulation, and the U.S.-China Agriculture Trade
China's
There remain serious problems within the U.S. China bilateral agriculture trade relationship, however. Many in the U.S. agriculture industry lobbied
China's agribusinesses have pursued outbound investment in several countries and sectors in recent years. In
China's
In the absence of effective regulation by the Chinese government, U.S. consumers depend on U.S. food safety inspectors to provide protection against the importation of unsafe food products.
Conclusions
Trade and Economics Year in Review
. China underwent a once-a-decade leadership change with a new president and premier and several new members of the
. The new Chinese leadership introduced initiatives aimed at reducing inequality, cracking down on corruption, and promoting urbanization. There are significant impediments to the government's ability to implement these reforms. For example, corruption is endemic at all levels of government, while local governments oppose urbanization due to fear that they will be overwhelmed by a flood of new migrants. China's progress in external rebalancing following the financial crisis was only temporary and largely driven by a weak global demand that reduced the relative size of China's export sector. Trade data for 2012-13 show that Chinese exports are again growing at a higher rate than imports, signaling a continued reliance on exports to fuel economic growth and a reversal in reducing China's massive trade surplus. As a result of failed measures to rebalance its economy, China has continued to expand its already record foreign currency reserves, reaching
. China's trade surplus with
. China has had little success transitioning toward a consumption- led growth model and reducing its reliance on massive infrastructure projects to boost economic growth. Consequently, China's high investment levels have led to overcapacity in multiple industries, including steelmaking, shipbuilding, and solar panel manufacturing. A slowdown in urban household disposable income growth and an increase in the household savings rate have cut into consumer purchasing power and contributed to a decline in total retail sales growth.
. Chinese officials have played down the significance of lower growth, saying the slowdown is partly due to economic rebalancing. However, the government continues to stimulate the economy through a variety of small steps. For example, the
. Due to its restrictive monetary policy, China's central bank has accumulated the world's largest foreign exchange reserves. The bulk of these reserves are invested in U.S. Treasury securities, so that Chinese ownership accounts for nearly one-quarter of foreign-owned U.S Treasuries. In addition, China's two largest sovereign wealth funds,
.
. China's attempts to keep the value of the RMB artificially low while strictly limiting the flow of RMB from the country, coupled with its efforts to control a large state banking sector, led to a banking crisis. The collapse in liquidity threatened economic growth in
. The fifth round of the U.S.-
. China continues to take incremental steps toward RMB internationalization, but the goal of making the RMB a major international currency remains out of reach as the government continues to maintain strict controls on cross-border capital flows.
.
Trends in
. Chinese foreign direct investment (FDI) in
. Official statistics underestimate the true volume of Chinese investment, because they do not account for flows of FDI through
. To date, state-owned enterprises (SOEs) have dominated Chinese FDI in
. Chinese investors have primarily targeted those sectors where China lacks know-how and technology, particularly in the
. Due to the considerable government ownership of the Chinese economy, provision by Chinese companies of critical infrastructure to U.S. government or acquisition by Chinese companies of U.S. firms with sensitive technology or intellectual property could be harmful to U.S. national interests.
. Investigations by CFIUS and other national security review and mitigation mechanisms may be hampered by limited resources or limited statutory authority.
. Investments made by Chinese state-owned or -controlled companies can also pose economic security threats. The Chinese government provides significant financial and logistical support. This puts U.S. firms, which receive no such support, at a competitive disadvantage. When Chinese SOEs invest abroad, they do not necessarily seek profit and may instead pursue government goals such as resource acquisition or technology transfer.
. Chinese investments in
. In areas where there are no national security considerations, and when the investment is driven by economic rather than strategic rationale, Chinese FDI can benefit the U.S. economy through creation of jobs and other positive spillovers.
Governance and Accountability in China's Financial System
. The Chinese economy weathered the first few years of the global economic downturn by doubling down on its time-tested strategy of funneling capital into domestic development projects. But five years on, global demand for Chinese exports remains too weak to sustain the country's factories, much less new ones, and the merits of massive infrastructure projects have more than run their course. The policy decisions that kept the Chinese economy chugging over the last few years have also sped it closer to a reckoning that economists have long forecast would eventually be necessary. If a rebalancing of the U.S.-China economic relationship is to be achieved, China must reform its financial system to support newer, nonstate sources of economic growth, which will require that China's banks better service its private sector.
. As long as China's official, regulated channels of credit do not possess the flexibility to meet the needs of the Chinese economy's main job creators, China will be at risk of depressed economic growth, which in turn may limit the growth of U.S. exports to China and the prosperity of U.S. investments in
. The opacity of Chinese corporate governance and accountability policies, as well as conflicts with U.S. securities laws and regulations, hurts investor confidence in Chinese companies trading on U.S. exchanges. The current situation threatens U.S. investors with unforeseeable and unmanageable losses and may lead to a broad delisting of Chinese companies. China's lack of sophisticated banking, corporate governance, and auditing policies and practices also hinders much-needed growth and opportunity for the very U.S. financial services firms that could help China to restructure its system if they were allowed greater access to the Chinese market.
. Insufficient transparency and accountability in China's financial sector put U.S. firms at risk of violating laws in both China and
China's Agriculture Policy, Food Regulation, and the U.S.-China Agriculture Trade
. For the past three years, China has been the largest export market for U.S. agricultural goods. However, trade is far from free, and enormous opportunities are being withheld. China's
.
. Since the 1980s, China has developed into the world's largest agricultural economy, producing a fifth of the world's grains, a quarter of its meat, and half of its vegetables. But demand in
. China's agriculture policy favors domestic production over imports. China maintains ambitious self-sufficiency targets that are unsustainable and unjustifiable in terms of food security. This policy is now being challenged by the decline in China's farm labor surplus, deteriorating land and resource endowments, and fragmented producer and land use systems. A related problem is that efforts to modernize agriculture conflict with rural welfare aims. Millions of rural migrants continue to rely on farmland and smallholder agriculture for insurance in the absence of a functioning welfare state.
. China has failed to fully perform its obligations under the
. U.S. companies, universities, and government agencies are helping China to improve the quantity and quality of its food output. In a sign of deepening bilateral ties,
. China is fostering globally competitive agribusinesses, in the process becoming an active acquirer of agricultural assets overseas. In
. China accounts for a large share of the fruits, vegetables, fish, and processed foods that Americans consume, but
Chapter 2: China's Impact on U.S. Security Interests
Military and Security Year in Review
China's late 2012 leadership transition brought the largest turnover to the
Since becoming CMC chairman, President Xi has used public speeches and visits to People's
In
During his first reported visit to a PLA base as CMC chairman in
In a meeting shortly after becoming the CMC chairman, President Xi urged senior PLA officers ''to take a firm stand against corruption'' and to maintain a ''strict work style'' and ''iron discipline.'' Since then, reducing corruption and waste in the PLA has been one of President Xi's most consistent messages in his public speeches to the military. In addition to rhetoric, President Xi has announced stronger anticorruption regulations for the PLA, including restrictions on military personnel holding banquets, drinking excessive amounts of alcohol, and using luxury hotels.
In
In
Since commissioning its first aircraft carrier, the
China also continues to pursue new space and counterspace capabilities. In
In late
In
In
China's Cyber Activities
In 2013, strong evidence emerged that the Chinese government is directing and executing a large-scale cyber espionage campaign against
The
There are no indications the public exposure of Chinese cyber espionage in technical detail throughout 2013 has led China to change its attitude toward the use of cyber espionage to steal intellectual property and proprietary information. It is clear naming and attempting to shame will not be sufficient to deter entities in
China's Maritime Disputes
Although sovereignty disputes in the East and South China Seas are not new, China's growing diplomatic, economic, and military clout is improving China's ability to assert its interests. It is increasingly clear that China does not intend to resolve the disputes through multilateral negotiations or the application of international laws and adjudicative processes but instead will use its growing power in support of coercive tactics that pressure its neighbors to concede to China's claims. Viewing a public defense of its maritime claims as central to political legitimacy, leaders in
In addition to boosting its presence in the East and South China Seas,
Conclusions
Military and Security Year in Review
. PLA modernization is altering the security balance in the
.
. The PLA is rapidly expanding and diversifying its ability to strike U.S. bases, ships, and aircraft throughout the
. The PLA's expanding involvement in real world missions allows it to field-test equipment and obtain hands-on experience in areas such as addressing unconventional threats in harsh and potentially hostile environments, satisfying expeditionary logistics requirements, and integrating into multilateral operations.
. The PLA is improving its day-to-day readiness levels and conducting longer-range and more frequent, robust, and realistic training. As these reforms continue, the PLA will become more proficient and confident operating its advanced platforms and weapon systems and better able to rapidly respond to regional contingencies.
.
China's Cyber Activities
. The Chinese government is directing and executing a large-scale cyber espionage campaign against
. China has not reduced its cyber intrusions against
. Developments in cloud computing in
. There is an urgent need for
China's Maritime Disputes
. China relies on a coercive and persistent maritime law enforcement and naval presence to gain control of disputed territory in the East and South China Seas. A consolidated maritime policymaking bureaucracy and streamlined maritime law enforcement fleets could increase
. Two key drivers shape China's approach to its maritime disputes: First, China encourages ardent popular nationalism, which it exploits to support its foreign policy aims in the East and South China Seas. Second, China views sovereignty over claims in the East and South China Seas as central to its national security, territorial integrity, and economic development.
. China uses legal and administrative measures to assert de jure governance over its disputed maritime regions; it deploys maritime law enforcement and naval vessels to its claimed waters to demonstrate and lay the groundwork for de facto governance.
.
Chapter 3: China and the World
China and the
China employs a multifaceted foreign policy approach to the
China is expanding and deepening its trade and investment ties with countries in the region. Between 2003 and 2012, China-MENA annual trade increased more than twelvefold, from
China seeks to develop and maintain friendly ties with all MENA countries without being drawn into the region's conflicts and power struggles. As such, China has more or less successfully maintained positive relationships with the major powers in the region, simultaneously strengthening ties with regional rivals like
China also seeks to leverage its relations in MENA in support of its own domestic security, particularly in the
In addition, China has taken steps to promote stability within MENA. Offers of support for the Israeli-Palestinian peace process, counterpiracy operations in the Gulf of Aden, and participation in UN peacekeeping operations in MENA are among China's contributions to regional security and stability. However, China also has undermined security in the region with its support for the Assad regime in
As China's interests and presence in MENA grow, they inevitably will impact U.S. objectives and influence. Although
Cross-Strait economic ties continue to expand and deepen. From January through
In 2013,
In
In
Despite warming cross-Strait ties, China continues to engage in aggressive espionage activities against
The recent cross-Strait rapprochement benefits
The gaming sector is the most important element of the
A 2007 evaluation by the
Since the report was published in 2007, there remain significant vulnerabilities with unlicensed junket operators and the junket affiliates that play an integral role in
The PRC's capital controls have caused more money to cycle through
Despite these stated goals, the dominance of the
Between 2005-2012,
Newly proposed legislation would further limit journalists. An antistalking bill that may be considered this year could hinder journalists' ability to seek out information from sources. Another law would limit personal data that corporate directors must make public. While supporters argue that this law is important for enhancing protections of individual personal data, detractors are concerned that it will unduly shield directors from media scrutiny.
Police surveillance is also a growing concern in
Conclusions
China and the
. China is expanding and deepening its trade and investment ties with countries in MENA. More than half of China's crude oil imports are from MENA producers, and China increasingly looks to the region as an export market for manufactured goods and services.
. Energy security is a key driver of China's engagement in MENA. As China's continued economic growth becomes more dependent on a steady supply of oil and natural gas from the region,
. China, driven primarily by its growing demand for energy, seeks to promote a framework for stability in MENA that supports its own economic, political, and security interests. These efforts include supporting the resolution of the Israeli-Palestinian conflict, conducting counterpiracy operations, and participating in UN peacekeeping missions. Conversely, China's position on the Syrian conflict and its support for
. China struggled to diplomatically adapt to regime changes across MENA during and after the Arab Spring.
. Most MENA governments appear to judge China plays a positive role in the region. Oil- and natural gas-producing states in particular look to China as their future primary market. Moreover, governments in
. Historically, China largely has avoided challenging U.S. influence and power in the
. Cross-Strait economic, cultural, and educational ties continue to expand and deepen. However, domestic political dynamics and priorities in
. Since the Commission's 2012 report,
. President Ma since his reelection in
.
. The rapid inflow of money to
. A combination of the PRC's strict capital controls and restrictions on the collection of gambling debts has given rise to grey market alternatives to facilitate the movement of gambling funds into
.
.
.
. Despite reports that the PRC aims to more closely monitor
. To protect their licenses to do business in
. Despite official statements of support from
. Prodemocracy activists express alarm over stepped-up police surveillance at protests, which they fear may be aimed at chilling public discourse or quelling public dissent.
. All of these trends run counter to the Basic Law's assurances that
. The systematic disenfranchisement of those who support greater democratic freedoms and civil liberties has created a climate of political polarization that may undermine
THE COMMISSION'S KEY RECOMMENDATIONS
The Commission believes that ten of its 41 recommendations to
The Commission recommends:
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COMPREHENSIVE LIST OF THE COMMISSION'S RECOMMENDATIONS
Chapter 1: The U.S.-China Trade and Economic Relationship
Section 2: Trends in
The Commission recommends:
1.
2.
3.
Section 3: Governance and Accountability in China's Financial System
The Commission recommends:
4.
5.
6.
7.
Section 4: China's Agriculture Policy, Food Regulation, and the U.S.-China Agriculture Trade
The Commission recommends:
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
Chapter 2: China's Impact on U.S. Security Interests
Section 2: China's Cyber Activities
The Commission recommends:
18.
19.
20.
21.
22.
23.
24.
Section 3: China's Maritime Disputes
The Commission recommends:
25.
26.
27.
28.
Chapter 3: China and the World
Section 1: China and the
The Commission recommends:
29.
30.
31.
32.
33.
Section 2:
The Commission recommends:
34.
35.
36.
Section 3:
The Commission recommends:
37.
38.
39.
40.
41.
Read this original document at: http://docs.house.gov/meetings/AS/AS00/20131120/101510/HHRG-113-AS00-Wstate-ReinschW-20131120.pdf
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