BEIJING (AdAgeChina.com) -- As the world awaits U.S. President Barack Obama's first few weeks in office, the U.S.-China relationship is a key issue on many peoples' minds.
Arguably the world's most significant trading alliance, bilateral trade between the two countries exceeded $380 billion in 2007. The U.S. and China accounted for more than one-third of the global gross domestic product that year. Now, the dynamics are changing.
For the first time in more than a decade, net trade between China and the U.S. is expected to decline in 2009 against the backdrop of the global financial crisis. In addition, when President Obama was sworn in on Jan. 20, China was the largest owner of U.S. public and private debt to the tune of $2 trillion.
The world is entering a new era of bilateral relations that will be shaped by unprecedented challenges, some of which we are only just beginning to understand.
In the midst of all the noise, there are a number of signals that could have implications for multinational businesses in the years to come.
With both economies cooling and looking for new growth engines, China and the U.S. are reevaluating their exposure to foreign markets. The deteriorating economic conditions will bring issues such as the trade deficit and currency manipulation back into the spotlight during the next Strategic Economic Dialogue (SED) session. The SED was introduced about two years ago at the joint initiative of President Hu Jintao and President George W. Bush. Four rounds of SED have been held since then.
American companies are beginning to allocate additional resources to their China operations, still a vibrant source of growth, and at the same time Chinese companies are beginning to explore unbelievable bargains and expansion opportunities in the U.S. market.
Given the current economic realities, many in China predict that Mr. Obama will, at least in the short-term, focus on how the two countries can work together to reenergize the global economy.
In the words of Huang Ping, director of the Institute of Sociology at the Chinese Academy of Social Sciences, "With the financial crisis spreading to the real economy, Mr. Obama is likely to pay more attention to trade issues; bilateral trade relations with China will be highlighted."
The poor economic climate in the United States directly affects the Chinese economy. China is already heavily invested in the U.S. economy, on many different levels. The Chinese government holds billions of U.S. dollar reserves and the China Investment Corporation (CIC), China's government-funded investment arm, is heavily invested in financial institutions such as Morgan Stanley and Blackstone. In fact, the CIC recently increased its holdings in both entities.
The future, however, for government-sponsored foreign investment does not look bullish. China's State Administration of Foreign Exchange (SAFE) recently announced that it will reduce investment in foreign equity in 2009.
China's Deputy Prime Minister Wang Qishan expressed his concerns for Chinese investments during then-Treasury Secretary Henry Paulson's recent visit to China, saying that the U.S. must work to stabilize its economy to "ensure the safety of China's assets and investments in the US."
In addition, CIC President Gao Xiqing has said Chinese people are not happy with the government's investments in U.S. financial institutions: "People here hate it. They come out and say, 'Why the hell are you trying to save those people? You are the representative of the poor people eating porridge, and you're saving people eating shark fins!''"
On a broader level, the financial turmoil will likely change the discussion surrounding China's currency practices, which has typically been a priority issue for the U.S. at the SED.
As Mr. Obama wrote in his China position paper in October 2008, "Central to any rebalancing of our economic relationship with China must be change in its currency practices...This is not good for American firms and workers, not good for the world, and ultimately likely to produce inflation problems in China itself."
It is important to note that progress on this issue was made over the last two years. China's currency, the RMB, had appreciated steadily by about 18% against the U.S. dollar between July 2005 and August 2008, until global financial markets were destabilized by the financial crisis.
On China's side, exports are slumping, and any further increase in the RMB's value would be problematic for domestic producers. During Mr. Paulson's visit, the RMB's value conspicuously fell 1% against the dollar, perhaps a signal that Chinese leaders are less willing than ever to tolerate preaching about currency manipulation.
Now it seems that China is the one giving economic advice, as Zhou Xiaochuan, governor of China's central bank, issued a statement saying, "The U.S. should speed up domestic adjustment, raise its savings rate and reduce its trade and fiscal deficits."
American consumers buy billions of dollars worth of Chinese products each year and more and more Chinese consumers are buying American. In fact, China is the third largest importer of U.S. products, after Mexico and Canada, and recently overtook Japan.
In this economic climate, both sides will be looking to take measures to boost consumption, creating pressure to loosen export controls and lift trade barriers in ailing industries.
U.S. companies will likely shift more resources towards their higher-potential China operations, while many Chinese companies will see this period as a good opportunity to acquire or merge with ailing U.S. companies.
This focus will make protectionist measures politically tempting, though many would argue that they would be counterproductive to long-term economic prosperity in both countries.
Conventional wisdom is that Republican presidents are economically favorable for China, as free trade is their mantra. Many people expect Mr. Obama, as a Democrat, will pursue a more protectionist economic agenda.
Watch carefully how the Obama administration handles inbound Chinese businesses and how China resolves disputes surrounding intellectual property, joint venture agreements, and the country's new anti-monopoly law.
That's the concern of Shi Yinhong, director of the Institute of International Relations at the People's University: "During the campaign, Mr. Obama criticized China's trade practices, and accused China of 'dumping goods into our market.' We can infer that Mr. Obama is a protectionist on trade issues." Sun Zhe, Director of the Center for American Studies at Tsinghua University, shares the same fear: "The news that Obama does not support U.S.
firms investing and operating overseas shows his protectionist tendencies." During the campaign season, both incoming Secretary of State Hillary Clinton and Mr. Obama frequently criticized NAFTA and other free trade agreements.
At the same time, Mr. Obama is quick to point out that the real source of U.S. economic woe is decreasing competitiveness, which he sees as a consequence of economic inequality, poor education, and deteriorating national infrastructure. Regardless of his political position, he will be under pressure from a vocal group in his own party to punish China for so-called unfair trade practices.
As a sign that protectionist policies may be on the horizon, the Obama administration recently indicated that the new administration will consider adding a "Buy American" clause in the pending economic-stimulus legislation. Protectionist measures could also include imposing quotas, tariffs, or taxes; pressuring China on currency valuation, or adding legal restrictions.
Any such moves could set off a trade war that would likely harm the interests of U.S. companies in China, Chinese companies in the U.S., and raise prices for consumers.
This would thwart many of the growth opportunities available for countries on both sides of the Pacific. It is unclear how the U.S. government will respond to inbound Chinese firms, and how severely the Committee on Foreign Investment in the U.S. (CFIUS) will scrutinize foreign investment in industries relevant to U.S. national security.
Lenovo's now-famous acquisition of IBM's PC unit was considered by some to be detrimental to U.S. national security interests, but the deal was ultimately approved.
The Obama administration will have to carefully balance economic opportunities and political sensitivities as more and more Chinese companies expand to the U.S. market. China's new anti-monopoly law, which came into effect last August, could potentially limit the growth of U.S. companies in China.
The new law is allegedly designed to promote free trade but questions remain as to how it will be enforced and whether it will favor domestic enterprises. Some legal experts say the impact will be minimal as long as foreign companies are bringing added-value.
Steve Dickinson of the chinalawblog predicts: "China will remain remarkably open to foreign investment. However, the fundamental principal is that foreign investment is expected to contribute something new to China. If nothing new is contributed...then the investment will not be approved."
Coca-Cola's planned acquisition of China Huiyuan Juice Group Ltd. is currently under review, and this will be the first major test of the legislation.
Joint venture partnerships between multinational corporations and Chinese partners will slow in certain sectors this year. One reason is economic uncertainty. Companies are putting off investment until business picks up. Japanese semiconductor company Elpida Memory, for instance, recently announced it will delay its manufacturing joint venture with a Chinese venture capital group.
U.S. car company Chrysler recently ended its joint venture with China's Cherry Automotive. Some analysts believe that there remains a cultural divide between East and West. But not all of the joint venture news is bad.
The financial services industry received a boost this month after Credit Suisse received approval to go forward with a joint venture with Chinese partner Founder Securities. It joins Goldman Sachs and UBS as the only global investments banks working with local securities firms. Morgan Stanley and Citigroup are awaiting approval for similar deals, which could further expand the investment banking sector for foreign financial institutions.
Intellectual property rights (IPR) are another key issue in China in 2009. Although the situation has improved since 2002, as China labors to comply with its World Trade Organization obligations, challenges persist.
The Bush administration made IPR a major priority in the SED and the issue received increased attention from foreign media in the run-up to the 2008 Olympic Games.
And it seems that anti-piracy efforts remain a major government focus in China today; in January, domestic media reported on the harsh sentence given to 11 people convicted of running an international piracy ring.
Product safety disputes could become a vehicle for economic protectionism in 2009. Initial questions about the safety of Chinese imports surfaced in March 2007 when the U.S. Food and Drug Administration (FDA) linked tainted imports of Chinese pet food to pet deaths from kidney failure in the U.S.
In August 2007, toy companies Mattel and Fisher-Price recalled millions of toys manufactured in China due to high levels of lead paint. In September 2008, concerns began to mount about infant formula and milk powder in China tainted with melamine, an industrial chemical that appears to make products more protein-rich.
Leaders in Beijing are concerned about the impact that product recalls may have on Brand China. Over the last two years, China has taken a number of steps to ensure the quality of its exports, including nationwide product and factory inspections as well as harsh penalties for those who endanger consumers through negligence or by dangerously cutting corners.
At the same time, China insists that product safety concerns should not be used as an excuse for protectionism.
Li Changjiang, director of the General Administration of Quality Supervision, Inspection and Quarantine, said in late 2007, "China strongly opposes some countries using product quality as a pretence to practice trade protectionism." Most analysts expect scrutiny of Chinese-made products to increase with the incoming administration, as a result of public demand and union pressure.
But Mr. Obama's views on the subject aren't entirely clear. In December 2007, he said that as president he would stop the importation of all toys from China. Soon after, his campaign clarified the statement that "any ban was meant to apply only to toys containing lead," and instead suggested that the U.S. send its own inspectors to Chinese toy factories.
President Obama's election has significant symbolic value in China. Political experts believe this could lead to greater appreciation of U.S. culture and values, and in turn will increase American "soft power" in China. This may benefit U.S. businesses at first only on the margins, but in the long haul could bolster the overall trade environment between the two countries.
In addition to representing change, in terms of political party and overall legislative approach, it affirmed the notion that in America, anyone can ascend to the country's highest echelons of power.
As described by Mr. He, a former Chinese diplomat who served in the U.S., "The election of Obama represents the beginning of a new era of U.S. history. There is no other country in the world that can compare to [the] U.S.A. In such a great country, a minority candidate armed with confidence, courage, personality, passion, and intelligence, can be elected president. This is the real story of the American dream, and Chinese people also appreciate the advantages of U.S. democracy."
Mr. Obama will take office following what is clearly acknowledged to be one of the least popular U.S. administrations, both domestically and abroad. The incoming administration has indicated that restoring America's image abroad will be a top foreign policy priority.
A boost in U.S. soft power could be valuable in helping both sides get off on the right foot, and may help to create more favorable conditions for U.S. businesses operating in China.
The Changing Geopolitical Environment
President Obama will solicit China's support on issues relating to North Korea, Pakistan, Zimbabwe, and Darfur, among others. He may be able to get it, but China will be looking for more breathing room on Tibet, Xinjiang, and Taiwan.
Fortunately for Mr. Obama, relations between Beijing and Taipei are warmer than ever. The same cannot be said about Tibet, which will remain a sticky subject. As always, choosing to pressure China here could have major repercussions. Mr. Obama's approach to these issues will be a clear test of his touted pragmatism.
The U.S. will continue to need China's leadership in managing North Korea. In addition, look for Mr. Obama to solicit China's support in bringing stability to the Middle East, particularly in Pakistan. China and Pakistan have historically celebrated close relations, as Pakistan was among the first countries to officially recognize the People's Republic.
One region that could become more central to U.S.-China relations is Africa, where China is becoming an increasingly active investor and a key player in solving some of the continent's most challenging humanitarian crises, such as the situations in Darfur and Zimbabwe. Given Mr. Obama's Kenyan heritage, many in China believe this could become a fresh point of discussion.
The former Chinese diplomat He Weiwen affirms, "As a son of a Kenyan, Obama could be more inclined to pay more attention to Africa than all other presidents. [Mr. Obama] once remarked, '[paraphrased] China's role in Africa is as impressive as the U.S.'s absence in Africa.' In the Obama administration, there will likely be more interaction between China and the U.S. about Africa."
Mr. Obama will be pressured to take a stand on key regional issues that China considers to be questions of national sovereignty. The two most high-profile conflicts -- Tibet and Taiwan -- are going through dramatic transformations. Relations between Beijing and Taipei are warmer than ever, and Taiwan is becoming a less-likely flash point.
Tibet could become increasingly tumultuous as the Dalai Lama publicly abandons his peaceful drive for "meaningful autonomy" and recedes from the international spotlight. China will continue be criticized on human rights, ranging from media censorship to its record on environmental protection to its treatment of dissidents.
As Dr. James Feinerman of Georgetown University recently wrote in the Washington Post, "China's stunted judicial system remained pervasively corrupt and ineffective... Free expression lacked protections; arbitrary arrests and detentions persisted."
And as usual, China will not be interested in soliciting international opinions on any of these topics, particularly on Tibet and Taiwan. If Mr. Obama were to make these issues a priority, the bilateral trade environment would likely deteriorate. This will be a clear test of his touted pragmatism.
This special report was written by Scott Kronick, president of Ogilvy & Mather Group in Beijing and president of Ogilvy PR in China, and Jamie Moeller, managing director of Ogilvy Public Affairs Worldwide in Washington, D.C.
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