The Hindu Business Line : US-China Strategic Economic Dialogue

The second round of the US-China Strategic Economic Dialogue, held in Washington in May, proved that while the Chinese are very serious about resolving issues, Beijing will not yield to external pressure. K. SUBRAMANIAN on the complex relationship.

When Mr Henry Paulson took over as US Treasury Secretary in July 2006, it was expected that he would bring about a breakthrough in the strained US-China economic relations. Indeed, he had the credentials. As the Chief of Goldman Sachs, he had made more than 70 visits to China and developed a personal rapport with senior leaders there.

He took charge around the time when there was a shift in White House policies on China. The New China policy of the Nixon era was giving place to fear and loathing of China as a rival or a threat. The neo-con hawks had sidelined doves like Robert Zoellick. While serving as Deputy Secretary of State, Mr Zoellick pursued a policy of looking to China as a "responsible stakeholder."

In an article in Financial Times (from the Shanghai Communiqué to "Responsible Stakeholder," May 2, 2007), he narrated how "given China's success, its size, its rising influence, it has an interest in working with other major countries to sustain and strengthen the international systems that keep the world more secure, enable it to be more prosperous, and open opportunities to our people." Many hoped that Mr Paulson's entry would bring this spirit back into US policies.

Truly, Mr Paulson sounded the right note about China. In his first speech in Washington as Treasury Secretary he acknowledged that while "many view the growth of China and its increasing importance as the clearest and most tangible threat of globalisation," he argued, "the prosperity of the United States and China is tied together in the global economy."

During later months as Treasury Secretary, Mr Paulson would have realised that resolving economic disputes with China is a different game from cutting loan deals with bankers and governments. His honeymoon was nearly over when he undertook the first visit to China in September 2006.

Much was expected of the visit. He led a delegation, which included six Secretaries of State and Prof Ben Bernanke, Chairman of the US Federal Reserve.

Though the Chinese authorities accorded the delegation utmost courtesy, there was no breakthrough on any of the outstanding issues, such as the yuan exchange rate, widening trade deficits and financial opening.

On his return, Mr Paulson commented that his only financial policy differences with the Chinese leadership were over "timing." It was no different from the stance Beijing had adopted since the dispute over the yuan rate erupted around 2002.

Bilateral forum

All that Mr Paulson could secure was a commitment to establish a Strategic Economic Dialogue (SED), a high-powered bilateral forum, to meet biannually to discuss and resolve disputes.

For the US, the SED had a parallel. It had attempted a similar procedure with Japan in the 1980s, when economic relations with that country were rupturing. However, the parallel cannot be over-played. Japan was a defeated country and a dependent ally, especially during the Cold War years. There were indeed attempts at arm-twisting on many issues to open up a sheltered or "mercantilist," as it was then described, Japan.

The attempt was not wholly successful. As Prof Lawrence Summers suggested, even in areas in which government policies might have had significant effects, "there is no evidence that Japan in the 1980s and 1990s made any changes in response to US pressure" ("A Japanese lesson for China," Los Angeles Times, February 26, 2007). He continued: "If heavy-handed pressure makes it easier for special interests to invoke nationalism as they resist change, high-profile negotiations can be counterproductive."

The second round of the SED was held in Washington on May 22 and 23 and received much press coverage. It seemed that China attached much importance to is as its delegation was led by the Vice-Premier, Ms Wu Yi, and included nearly half the cabinet.

Countering pressure

In an article published earlier in the Wall Street Journal, Ms Wu described the SED as an important channel through which economic issues of strategic importance are discussed and pressing questions resolved. She provided a foretaste of Chinese responses to issues that would be raised during the SED. The change this time was that the Chinese delegation was exposed to the outpourings of Congressional and Senatorial fury.

On the US suggestion of more action by China to cut its trade surplus, Madam Wu pushed back, saying Chinese currency was not the main reason for the gap and that Washington should ease high-tech export curbs.

The thorny issue of China's currency was unresolved and some members of the Congress, including Senate Majority Leader Harry Reid, threatened action unless Beijing did more to reduce the US trade deficit. All the same, they are circumspect in that the WTO may not be on the side of the US angels.

After meeting with Madam Wu, President Bush said: "This is a complex relationship. ... We've just to work through friction."

The Senators were not as realistic. Madam Wu did assure the US business leaders that the "floating band of the renminbi exchange rate will continue to expand as the market changes in the future." More significantly, she explained: "China's exchange rate reform will be advanced in an orderly way based on the principles of self-initiative, controllability and gradualism." In short, China would not yield to external pressure.

Shifts in Balance

These responses would not have been music to the ears of US business and politicians who look upon the RMB rate as the villain. However, there is awareness that the US does not have all the aces and that the shift in economic balance has weakened its ability to act. Hopefully, there will be greater maturity and realisation of global consequences to prevent unilateral action.

The Japan Times referred to the growing frustration on both sides and added: "The truth now, as it was a little more than a decade ago, is that both economies have structural problems and fixing them will take time. The key is to avoid mistakes that could have destabilising consequences for the world."

On their part, the Chinese have met some of the US demands, though incrementally. There is an agreement on aviation and details are to be worked out. There are some in financial services providing greater scope for foreign companies in securities, banking and insurance.

During his meeting with Madam Wu, President Bush made a request that Beijing lift the ban on importing US beef. The ban came about in 2003 in the wake of the mad-cow disease scare. The World Organisation for Animal Health has since downgraded the earlier risk assessment. It is quite likely that China will lift the ban.

Likewise, China may also meet the demand to control export of `poisonous' toothpaste, though no firm commitment was given.

It is noteworthy that China has been meeting such demands from the US from time to time, to reaffirm its friendly relations with the latter. Alongside the SED, it engaged in a shopping spree running into billions of dollars and made a foray into Blackstone, a private equity company. Sadly, the US has not reciprocated these gestures.

Successive rounds of the SED may go on. But the currency tangle cannot be resolved by SEDs alone. As Stephen Roach of Morgan Stanley ("Asia's Policy Trap", May 29) has elaborated, the US pressures on China to let the renminbi appreciate have accelerated hot money flows, forex reserve accumulation, continued rapid growth in money and credit and spillover in the equity market in China and elsewhere, and is becoming a vicious circle.

China has become the hub of the Asian economy in several ways. Given the integrated pan-regional supply chain, it is impossible for the rest of Asia to decouple from pressures that might affect the performance of the Chinese trade engine.

"Similarly, the fate of the RMB could well hold the key to currencies elsewhere in Developing Asia." Thus, if China were to act as a responsible stakeholder, it has to be in the regional and global context and not necessarily in the US context. This wisdom does not come easily or soon to US Senators.

(The author, a former Finance Ministry official, has experience in international, financial and trade issues.)

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