Part III

Institute for National Strategic Studies


Blue Horizon: United States-Japan-PRC Tripartite Relations

PART III

ECONOMY

PRECISION ECONOMIC WARFARE:
THE STRATEGIC IMPLICATIONS OF CHINESE AND JAPANESE INDUSTRIAL POLICIES

Ronald A. Morse

QUITE CLEARLY, JAPAN'S DUAL-USE TECHNOLOGICAL CAPABILITIES AND China's nuclear and conventional military strength are issues with strategic considerations. American foreign policy leaders understand these kinds of issues and know how to deal with them. Unfortunately, this clarity of mission and capacity for response does not exist with regard to long-term economic threats. There is, therefore, a need to examine recent changes in the industrial policies of China and Japan, which suggest that the United States is going to have to develop greater precision in its capacity to deal with economic threats if it intends to be a serious player in Asia in the future.

Because economic policy is so central to sustaining overall national strength, one can make the argument that the same degree of precision is needed in American analyses of foreign economic threats that we have been willing to make in the military-defense area. One might even make the extreme case that, while the level of American global "military" superiority is dramatic and can serve U.S. interests well into the 21st century, the relative weakening of American economic strength is more of an area of immediate concern. This would be less of a concern if our major economic competitors-China and Japan-were not so well organized and focused. The changes now underway in these countries suggest that their economic positions are in fact likely to be strengthened as the result of recent policy changes.

Ronald A. Morse is the Director of International Projects and teaches a course on global competitiveness in the business school at the University of Maryland. Before his present position Mr. Morse was Adjunct Professor of International Business at the Fletcher School of Law and Diplomacy, Tufts University. He is also the author and editor of over a dozen books.

While American policymakers do spend considerable time focused on economic issues, they have consistently underestimated the longer term "powerful system properties," created from the organized use of economic complexity. System properties in the Asian context means "industrial policy." Japan and now China are concerns to the United States because of their ability to create home-based economic advantages that give a nation comparative advantage in the global marketplace. This economic advantage has long-term national security implications often not fully appreciated in Washington. This issue is especially important in the post-Cold War era, in which there has been increasing emphasis on the importance of economic competition and technological superiority relative to military confrontation.

Economic factors in the assessment of national strength tend to change more rapidly than do military capabilities, especially under the guidance of the strong bureaucratic initiatives that industrial policy makes possible. This point is best made by pointing out that the American concentration of resources and talent into the defense bureaucracy and establishment has created an unrivaled military superiority. The United States has not been able to to the same in the economic arena, a field in which the Japanese have demonstrated a superiority. Japan's economic success, like that of the Defense Department, is founded in the concentration of resources.

Because of the dynamic pace of economic change in Asia, China and Japan are being forced to shift their earlier economic strategies in radically new directions, markedly different from where they were headed just a couple of years ago. Japan, more familiar to Americans because of the continued debate about the Japanese threat, is moving away from its over-regulated and protected industrial policy model toward a more open and deregulated style characterized by much less bureaucratic centralism. Some people are skeptical about this change, but it is significant enough to warrant our attention. China is moving in a new and opposite direction from JapanCfrom a fragmented, under-regulated economy to a more centralized system of developmental state, emphasizing the economic foundations of state power. Japan has also been a "problem" for American policymakers because it represents a "nontraditional" form of threat; as a nation exclusively concerned with its own economic development and with little interest in military power, it has been easy to underestimate Japan's prowess. But as political and security implications of technological and economic power have been clarified, greater attention was focused on Japan's economic potential and the policies that account for its strength. But now, as the recent difficulties in U.S. negotiations with the Japanese have made clear, we need to update our understanding about the dynamics of Japanese economic behavior at home and in Asia.

With China, the major concern among foreign experts has been that it might not be successful in its economic plans, and this would in turn lead to a major political breakup. The basic assumption was that as long as China prospered economically it would be less likely to be militarily adventuresome. Now, the situation seems to be reversingCChina just might be very successful with its long-term economic policies and, in the process, become a significant "regional" military power and quickly evolve into a "global" economic power.

While some writers have suggested that China's President Jiang Zemin is swerving away from Deng Xiaoping's economic pragmatism in his own drive for political control, I would argue that the difference is that Jiang is jumping from a socialist economic model to an Asian modernization formula for economic policy, from a political tolerance of decentralized market forces to a more integrated and institutionalized form of industrial policy. Because of its current intense focus on fostering core industrial strength, China is also moving toward more of a Japan style of "nontraditional" type of threat at the same time that it flexes its military muscles.

Unfortunately, there is little new thinking on Japan and there is virtually no American consensus about what would constitute an effective China policy. Moreover, a continued failure to address these economic issues could actually become a serious U.S. liability given the high pace of change in Asia. Behind this neglect there is a consistent underappreciation in policy circles of the general logic of Asian economic developmentCthat economics dominates politics, the center dominates the periphery, markets are reconciled with strong government, and military considerations are reconciled with limited budgets.

The ability of the United States to influence Chinese and Japanese economic policies is also limited by these facts:

THE CONTEXT OF ASIA
Asia's impressive growth over the past decade comes as no surprise to experts familiar with the early growth stages of European and American economic history. Asia's high growth will no doubt taper off in the years ahead, but given the size of the region, its large population, and the magnitude of wealth being generated, Asia will remain the fastest growing market for decades to come. To some degree, the early phase of Asian economic growth was sustained by Japanese infrastructure investment and overseas development assistance. A future major growth surge is still possible because of the reduction of trade barriers and the new emphasis on "open regionalism" being promoted through APEC and other regional trade groups.

While there is no need to review the story of Asia's economic success, it might be useful to reiterate just a few facts about the Asian-Pacific region:

THE CASE FOR INDUSTRIAL POLICY
In good part, American miscalculations about foreign economic threat regarding Japan and China derives from the political and ideological biases of U.S. leaders regarding the government's role in state planning. This is particularly true when it comes to government intervention in the business of the economy, what is considered the issue of "industrial policy." At the risk of sounding simplistic, a little background about "industrial policy" as the Chinese and Japanese now conceptualize it, is important for the later discussion.

It is one of the great ironies of America that industrial policy is something that the U.S. Government is happy to practice in agriculture and defense (under the rubric of national security) despite a pervasive ingrained political distrust of centralized policies in the economic area.

Americans have always emphasized political fragmentation and a Darwinian view of the worldCthey tend to undervalue the role of institutions in economic policy formation. Western economists also assume that the market allocates resources efficiently, that technology is increased through the accumulation of knowledge, and that prices are all the information that is needed for maximizing economic progress.

The East Asian development model defines government intervention as ensuring sufficient human investment, creating a competitive environment for private companies, maintaining an open economy for international trade, and maintaining macroeconomic stability. Japan has been a conscious and successful practitioner of developmental economics, and China is quickly becoming one of its latest converts. In fact, the Japanese have been coaching the Chinese about the virtues of industrial policy for over a decade.

The phrase "industrial policy" also refers to official measures to channel economic resources into specific sectors and activities of the economy that are considered important for economic growth. Economic strategy emphasizes manufacturing because of manufacturing's positive contribution to growthCthe jobs pay more, manufacturing exports earn more, service and specialized technologies and communications are linked to manufacturing, and it is essential to an independent national security.(Note 1)

Like manufacturing, strategic industries create improvement throughout the economy. There are four hypotheses about this:

In a market economy there is a strong presumption that competitive forces channel resources into their most productive uses. However, as industrial policy advocates argue, sometimes markets fail. When they do, government intervention may well be appropriate. Industrial policy is not necessarily a market-based economic model; it involves tradeoffs between long-term growth in select industries and the short-term costs of resource dislocation.

Thus, industrial policy is based in a fundamental distrust of the market, requires a professional bureaucracy with the authority to allocate resources and technology, and needs to be based in an outside consensus over goals for the resource redistribution. In the case of China, for example, it reinforces the Chinese link between administration and enterprise. It is also bolsters the socialist argument for an emphasis on public goods over private interests, a useful tool for example in the current anticorruption campaign.

Industrial policy is also about the ability of a country's entrepreneurs to design, produce, and manufacture goods and services that are better and cheaper than those of the international competition. Industrial policy is also particularly important when a nation wants to compete in a quick and efficient manner. Industrial policy can obviously serve many purposes: it provides information about economic goals and is educational; it is a statement of long-term commitments; it serves to mediate differing interests; and it supplies a vision of a desired future situation. Industrial policy is implemented through legislation, fiscal incentives, financial incentives, tax incentives, administrative guidance, subsidies, procurement, regulation, credit, etc.

China
Industrial policy fits well with China's current goals. Basically, China's economic performance in 1995 was healthyCgrowth cooled to 10.2 percent, there was a record grain harvest, and China's trade volume grew 18 percent, to $280 billion. China has also met the basic human needs of its people and is entering the ranks of midlevel industrial countries. It also has $70 billion in foreign reserves to back its debts and import needs.

Nevertheless, it has fundamental structural problems that need to be addressed in a systematic fashion, primarily in the financial system that needs an overhaul and the wasteful inefficiencies of the state-owned enterprises that gobble up 70 percent of the investment, 90 percent of the loans, and (over) employ nearly a fifth of the population. China will also require $250 billion for infrastructure investment between now and the year 2000. As one person has framed the argument, China has a powerful economic engine, it is in the passing lane, but it needs better brakes and power steering. In essence, it needs an effective industrial policy.

In a study for the Department of Defense in 1994, China in the Near Term, it was argued that one of the central problems in China was the absence of a network of civil institutions that could serve as the social glue that would give people a sense of political participation. (Note 2)

Without this glue, it was argued, China might break up. The assumption was that, in addition to the Communist Party and the military, some institutional arrangement was needed to help transition the society to modernization while creating a sense increased participation and opportunity. Since 1994, and with the transition of power to President and Communist Party chief Jiang Zemin, the one new development to emerge that could alter this earlier interpretation of China's prospects is the focus on recentralization around an industrial policy strategy.

If this interpretation of economic policy trends in China is correct, the new industrial policy emerging in China could provide the national cohesion and sustained economic growth that will minimize concerns with political freedom (as it did in Japan, Korea and Taiwan) as long as incomes and economic progress are sustained. If China's industrial policy strategy proves effective, it could be the economic tool that gives the Chinese leadership an adequate slogan for centralized economic management, the ability to deliver sustained economic growth, and a way to justify delays in political democratization. This would be consistent with President Jiang Zemin's agenda to win popular domestic support for his leadership, eliminate his critics and opponents, rein in the provinces and get control of taxation, and put his own post-Deng stamp on China's reforms.

This is also consistent with the recent calls by neo-authoritarians in China who are concerned about China's armies of migrant workers, vast regional inequalities, rising crime rates, and the decline of Marxist ideology. Their calls for a new unifying system and program of Communist rule fits well with the operational principles of industrial policy thinkingCa strong centralized bank, reinvigorated state-owned enterprises, and a more effective taxation system.(Note 3)

The key institution for China's new industrial policy will be in the State Planning Commission (SPC), the agency with the mission to "define China's economic trajectory for the rest of the decade and beyond." The SPC is China's premier government body for economic policy, and it has been expanding rapidly given its new responsibilitiesCin July 1995 it formed the 750-member Academy of Macroeconomic Research as part of its Economic Research Center. The Academy has nine research institutes and is "expected to provide timely and accurate information for the decision making of the SPC and the Communist Party's Central Committee." The new State Development Bank under the SPC is key to this industrial policy planning.(Note 4)

The importance of China's new industrial policy program was revealed on October 9, 1995, in a report on Party Chief Jiang Zemin's September 28 speech on the "12 relationships"-a speech reportedly made at September Central Committee meeting. Echoing Mao Zedong's 1956 speech of "ten major relationships," Jiang draws on historical analogy to spell out the role of modernization under the conditions of a socialist economy.(Note 5) In October 1995, a conference was held in China sponsored by the State Planning Commission that focused on comparative industrial policies.

The re-centralization of economic policy around an efficient economic development plan is an important recent development in China that seems to have received little outside attention. The impression is that China is consciously following the economic development models of Korea, Japan, and Taiwan as it formulates its strategy. This could mean that, as recent policy pronouncements have suggested, China might become more economically centralized and nationalistic.

There is also evidence that the Chinese bureaucracy has developed the expertise, statistical control, and policy knowledge to implement an industrial policy successfully. More importantly, the current emphasis on industrial policy represents a reversal of the earlier weakening of central control, decentralization, and localization policies of the past decade. This strategy also goes beyond the policies of earlier plans in that the legal and economic infrastructure is in place to manage it in an effective way. (Note 6)

To be sure, the idea of a central planning has been around China in one form or another since 1949. In the 1960s, regional autonomy was important. From 1985, coastal zone development was emphasized, and now the focus is on a more orderly strategy for economic development. This is also reflected in the movement from a policy emphasis on agriculture to light industries and now to the state-owned enterprises. (Note 7)

The March 1994 "Outline of an Industrial Policy for the 1990s" is a benchmark statement in the central government's decision to formulate a comprehensive strategy to use technology, labor, and natural resources more effectively with the State Planning Commission at the center of this process. Beijing is now squeezing state-run companies, overhauling trade, simplifying taxes, canceling preferential policies, and reforming banks.

This turn to industrial policy as an economic and political tool has been motivated by a sense in China that the government's position in the economy has weakened, that coordination costs are high, and that demand is outgrowing technology. Out of this has grown the awareness that managing the new China requires better economic instruments. Statements indicate that as China moves toward a disciplined and more integrated economic miracle, the focus will be on:

To be sure, China has struggled with various models of economic growth for over a century. The overriding goal in each case has been to enhance China's strength and prosperity while ensuring social stability. Things have not always gone smoothly; early versions of capitalism failed and the inefficiencies of the Cultural Revolution created a variety of problems. Since 1979, industrial policy has been on the minds of China's economic leaders, and they have now put in place the instruments to implement a comprehensive "industrial policy."

Even with a plan, many people are skeptical about China's ability to implement such a strategy. And even if they can implement an industrial policy, China's task to attain sustained growth will not be easy. Today, China has a large population, an agricultural sector struggling to modernize, a backward and imbalanced industrial structure, a dependence on foreign trade and investment, a weak financial market, and increased demands for high growth.

Nevertheless, China's progress to date has been impressive. Latecomers to development benefit from the experience of others; have easy access to technology; enter into interdependency with nations more quickly; and can develop new economic command and control mechanisms. Industrial policy can help identify demand trends, guide adjustments in industrial composition, and define the role of competition. Some of the primary tasks for long-term economic development, according to the September 1995 Fifth Plenary Session of the 14th CPC Central Committee, were: strengthening primary industry, applying advanced technology and education, and ensuring a well-coordinated economic development in all regions. Industrial policy was highlighted as one of the seven key issues.

China's long-term goals in this process are clear: join the World Trade Organization, establish a commercial banking system, make state owned enterprises efficient and productive, make currency convertible, and sharpen the lines of government economic authority. Over the last 2 years, Chinese efforts to bring inflation under control, crack down on corruption, and put in place better macroeconomic controls are indications that they are taking economic planning more seriously.

Japan
While China now approaches its economy much as Japan did in the late 1950s, Japan is now abandoning the constraints of its overly managed economy for a more open, market-oriented strategy. There is no question that for the past 8 years Japan's relative global competitive position in manufacturing has been slipping for a number of reasons, including reduced productivity growth and declining price competitiveness because technological advancement cannot compensate for high wage disadvantages. The adjustment has been much slower than many had hoped for, but transformation is likely to accelerate further in the year ahead.

In 1996, Japan will experience the first significant surge in its economic growth since financial troubles surfaced in 1991. This growth is the result of several factorsCexchange rate adjustments, changes in regulations, industrial restructuring, and most importantly, capital investment, overseas direct investment, and employment gains centered on the medium-size and small firms that account for 70 percent of total economic activity. Competitive industries are strong in international markets, and Japan's dependency on foreign markets in manufacturing is growing.

In this process, the Japanese have had to make some hard choices. Generally they have decided to avoid workforce cuts, approach deregulation selectively, and allow the banking and credit crisis to be worked out through a process of shared public/private adjustment. Land prices have fallen, wage increases and consumer prices are down, and Japanese firms are making more goods in foreign factoriesCabout 8.9 percent of all production took place overseas in 1995, up from only 3.2 percent in 1986.

The implications are profound. Japan will come back as a strong competitor, it is basing its strategy on Asian markets, it has significant aid and financing resources to put behind its projects, and it is still strong in manufacturing and technology applications. Even more important, U.S.-Japan ties have weakened and Japanese overdependence on the U.S. market for exports is ending. Tokyo is emerging as a more independent and more focused actor on the global economic scene.

IMPLICATIONS
Like it or not, U.S. policymakers will have to give serious consideration to these shifting economic strategies in China and Japan. While U.S. leaders are feeling good about America's seemingly stronger global economic position, it is important to realize that the rest of the world has not been standing still waiting for us to catchup. Japan has come through its recent economic difficulties stronger and without the social disruptions of American corporate downsizing and restructuring. And now that they are moving toward a more market responsive economy, they are also reinforcing government incentives for S&T and regional infrastructure investment, just at a time when we are doing the opposite. All of this coincides with Tokyo's aggressive networking and investment in Asia: The U.S.-Japan trade deficit is declining, and Tokyo is willing to confront U.S. Trade negotiators in GATT and the WTO.

China's recent behavior also gives pause for concern. If Beijing's recent hardline in foreign affairs was based in economic weakness, they would be vulnerable to any number of pressures. But if that is not the case, then they could pose a considerable challenge to U.S. interests. But even more important is the hope that a successful industrial policy holds out for China's leaders as they seek to minimize domestic political difficulties over the next decade while dramatically increasing China's economic strength.

Even though many American analysts argue that this is not a time for bold initiatives in our Asian relations, that choice may no longer be ours to make. China under any scenario is the primary loose-end in the global system. It is not part of any collective security arrangement, it is determined to expand its nuclear and conventional weapons arsenal, it is still ideologically driven, and it will most likely become an economic superpower. Japan is also on the rebound and much more confident about its potential strength. Many of its electronics and manufacturing firms are doing well in Asia, and once the domestic market is deregulated other industries will prove very competitive in the global market.

Economic Dimensions of Tripartite Relations

Frank Ching

AFTER THE COMMUNIST VICTORY OF 1949, THE COLD WAR ENSURED THE isolation of China by both the United States and Japan. Then, during the Vietnam war, the common perception in Washington and Beijing of a Soviet threat resulted in the emergence of a detente between the United States and China, which was accompanied by a thaw in the Japan-China relationship as well.

The forging of official diplomatic relations in the 1970s was followed by a flowering of the economic relationship, but one that was seen as subservient to the political relationship. The end of the Cold War brought about a reassessment of the U.S.-China relationship, primarily on the part of Washington, with the United States downgrading that relationship with the perception that China was no longer needed as a counter to Soviet power. The U.S.-Japan relationship underwent a similar reassessment, a process that is ongoing. Meanwhile, the Japan-China relationship, which was perhaps the least politicized in this tripartite relationship, is also undergoing change, in part because of change in the other two sets of relationships.

Frank Ching, a Senior Editor with the Far Eastern Economic Review, writes a weekly column, "Eye on Asia," in which he comments on political developments in the region. He is also the co-host of a weekly current affairs television program, "Newsline." Previously, he was on the staff of The Wall Street Journal and The New York Times.

The united states-China Economic Relationship
As has been said, the beginning of the U.S.-China economic relationship was very much a function of the political relationship, as China's value to the United States was seen as the geopolitical role the country could play. However, while the Cold War is now over, politics still plays a major role in the economic relationship, in large part because of the American propensity since the Tiananmen Square military crackdown in 1989 to link human-rights issues with trade issues. In fact, the economic relationship is virtually hostage to the political relationship because of the American legal requirement that China's most-favored-nation (MFN) trade status must be renewed annually. When faced with American threats to cut off MFN, China has responded by indicating that it will retaliate. Thus, when President Jiang Zemin visited Seattle in 1993 to attend the APEC leaders meeting, he pointedly visited the Boeing aircraft factory as well as the home of a Boeing employee to underline the fact that exports to China create American jobs and that such jobs would be at risk if the United States took unilateral action to curtail Chinese trade. The current interdependence of the Chinese and American economies was made manifest when President Clinton decided in 1994, after major soul searching, to delink MFN and human rights, recognizing that damage to China's economy cannot be achieved without also damaging the American economy.

China's global economic importance has grown dramatically since late 1978, when the Chinese Communist party announced that it would give top priority to the country's economic development rather than to class struggle, as had been the case in the past. Since 1978, China's economic reforms have lifted a couple of hundred million people from abject poverty, though China itself acknowledges that 70 million people in the country still live below minimum subsistence levels. Internationally, China has moved from an insignificant trading nation to one of the world's largest traders, with its global trade in 1995 totaling $280 billion, a 22.9 per cent increase over 1994. China's total trade with the United States in 1978 was little more than $1 billion; in 1995, it was in the neighborhood of $60 billion. On whole, the United States and Chinese economies are largely complementary, with the United States being in a position to provide needed capital and technology while China supplies the United States with competitively priced, low-tech goods made with cheap Chinese labor. At the same time, each provides the other with a large and valuable market.

The biggest cloud hanging over the relationship, aside from such noneconomic considerations like human rights, is the big and still growing U.S. trade deficit. Only recently, the U.S. Trade Representative, Mickey Kantor, while acknowledging that the relationship benefits both parties, asserted that it benefits China more. "For most Americans, the growing U.S. trade deficit with China is deeply troubling." Kantor said. "China last year ran an estimated $35 billion trade surplus with the United States. Our deficit with China is threatening to surpass our trade deficit with Japan. The Japanese deficit is falling. The deficit with Asia excluding China is falling."(Note 1)

It is ironic that Kantor should have reprimanded China by saying the U.S. deficit with China was growing while its deficit with the rest of Asia was falling. It is precisely because the deficit with the rest of Asia is falling that the deficit with China is rising. The rest of Asia, in particular Hong Kong and Taiwan, has exported U.S. trade surpluses to China by relocating manufacturing facilities in China to take advantage of its lower manpower costs. Thus, most of the profits from these exports to the United States are enjoyed by entrepreneurs in Hong Kong and Taiwan, while the Chinese earn only a modest processing fee, typically less than 20 percent of the value of the product.

This becomes evident when U.S. trade with Greater ChinaCChina plus Hong Kong plus TaiwanCis considered as a whole. Looking at China in isolation, U.S. Department of Commerce figures show the U.S. deficit widening dramatically from $2.7 billion in 1987 to $18.3 billion in 1992, an almost 700 per cent increase. However, by adding Hong Kong and Taiwan into the equation, one sees that the U.S. trade deficit during that period rose gradually from $25.8 billion in 1987 to $28.3 billion in 1992, an increase of less than 10 per cent over a period of 5 years.(Note 2) This trend is borne out by figures since 1992. Thus, the growing American trade deficit with China primarily reflects the economies of East Asia capitalizing on comparative advantage, with China having been transformed into a gigantic processing zone for the rest of Asia. It is not surprising, therefore, to discover that foreign-invested enterprises in China account for well over a third of total Chinese exports.

It appears, then, that increased U.S. imports from China are a result of decreased U.S. imports from the rest of Asia. In effect, Chinese exports have merely replaced other Asian exports to the United States, with no deleterious effects on the American economy. The U.S. deficit, therefore, need not be as politically sensitive as it is made out to be.

Furthermore, the way in which the United States calculates the size of the surplus is open to question. Much of U.S. imports from China are routed through Hong Kong. The United States rightly counts these as imports from China rather than Hong Kong, but in calculating the value of these imports, the United States chalks up to China's account the value added in Hong Kong, which according to Hong Kong figures is roughly 25 per cent. This value-added makes a considerable difference and should be subtracted from the value of China's exports. Because 70 per cent of China's exports to the United States go through Hong Kong, such systematic overcounting renders the U.S. data seriously flawed.

Ironically, U.S. exports to Hong Kong that are re-exported to China are considered by the United States to be exports to Hong Kong rather than exports to China. This means that U.S. figures understate the value of U.S. exports to China while overstating sales to Hong Kong. While much less than the volume of Chinese exports to the United States that passes through Hong Kong, such re-exports are still considerable. In 1994, for example, Hong Kong reported that $3.7 billion worth of U.S. goods were re-exported to China.(Note 3) Recalculations of Chinese exports to the United States through Hong Kong by subtracting the value added in Hong Kong substantially reduces the total value of Chinese exports to the United States. Similarly, recalculating American exports to China by including products sold through Hong Kong increases the value of American exports to China. These recalculations reduce the overall China trade surplus. In 1994, for example, while the United States claims a deficit of $29.5 billion in its trade with China, re-adjustments along the lines indicated above reduce the deficit by about $10 billion, or roughly 33 per cent, to $19.7 billion. Experts from the United States and China are now discussing just how their trade ought to be measured. It is to be hoped that, before long, the two sides will reach an agreement as to how to measure the trade that passes through Hong Kong. Such an agreement will put the trade deficit into perspective and, one hopes, depoliticize it.

Other major issues in the U.S.-China economic relationship include the protection of American intellectual property and market access. Protection of intellectual property is an issue on which the two sides reached an agreement a year ago, and the question now is one of enforcement, with the Chinese claiming they are doing as much as they can and the United States saying they can be doing more.

As for market access, there is also an agreement, reached in 1992, under which China agreed to dismantle 30 per cent of its import restrictions, including licensing requirements and quotas, within a 5-year period. In addition, China agreed to such steps as the elimination of import substitution regulations and the import regulatory tax, reduction of tariffs, and improvement of the transparency of its trading system.(Note 4)

The issue of market access is complicated by American export controls that restrict exports of goods, service and technology with military or dual-use civilian and military application. Thus, there are instances when the Chinese desire to buy from the United States but are unable to do so because of American regulations against exporting to China.

The United states-Japan Economic Relationship
Well before the end of the Cold War, the U.S.-Japan economic relationship was seen to be in serious trouble. The economic relationship was regarded as one of three pillars of the overall relationship, the others being the security alliance and global diplomatic cooperation. However, trade friction arose as early as the 1960s, with Japanese exports of textiles and steel. Relieved of the need to put any great resources into national defense, the Japanese focused on economic development and, by the 1970s, became world leaders in the areas of television sets, cars and machine tools. By the 1980s, Japan had come to dominate the U.S. consumer electronics market, along with South Korea and Taiwan.

As American consumers were increasingly drawn to Japanese products, the U.S. trade deficit, which stood at about $4 billion in 1972, began to soar, reaching about $50 billion a year in the mid-1980s. In an attempt to remedy this situation, Japan agreed to raise the value of the yen in order to make Japanese exports more expensive and make American exports to Japan more affordable.

However, the expected fall in the U.S. trade deficit did not materialize for years, despite the yen's continuing rise. Part of the reason was the willingness of Japanese exporters to reduce their profit margins in order to retain market share. But a more important reason was a restructuring of the Japanese economy, with Japanese companies cutting costs by setting up production facilities overseas and later increasingly importing the products of those subsidiaries back into Japan. This had the effect of transforming Japanese companies into modern global enterprises.(Note 5)

The upward valuation of the yen in order to increase American exports was not a failure. American exports to Japan did rise. But, at the same time, U.S. imports from Japan also increased, and so the trade deficit remained high. And, in the 1990s, Japan's trade surplus with the United States continued to increase, reaching another high of $59.3 billion in 1993. That year, the yen began another round of sharp appreciation in value. On a yen basis, Japanese exports began to decline, but because of the yen's strength, in dollar terms Japanese exports were still rising. (Note 6)

In the Structural Impediments Initiative round of talks, the United States called for structural changes in the Japanese distribution system and reform of exclusionary business practices and relations. The Japanese called on the United States to reduce the federal budget deficit, to increase the savings rate, and change the practice of companies focusing on short-term gains.

The United States wanted to open the relatively closed nature of the Japanese economy. While tariffs on the average are low, government regulations and informal business practices combine to impede foreign imports and investments. After the Clinton administration came into power, it felt that previous American agreements with Japan had not brought about the desired results and so decided to adopt what it described as a results-oriented stance in trade negotiations. It opened new talks, which culminated in a Framework Agreement in July 1993. Under this agreement, the United States promised to reduce its budget deficits and improve its competitiveness while keeping its markets open. Japan for its part promised to boost domestic demand to reduce its current account surplus, as well as to increase market access for foreign goods and services and to open specified sectors of its economy to more imports and greater foreign investment.

Japan resisted U.S. efforts to introduce either "numerical targets" or "numerical indicators," and the two sides settled for the term "objective criteria." Subsequently, the two sides could not agree on the interpretation of "objective criteria" for evaluation of policy implementation. The atmosphere was exacerbated with the United States suffering another record trade deficit with Japan in 1993 of $59.4 billion. Japan accounted for more than half of America's global trade deficit.

Further talks, often characterized by undisguised rancor, were held. The United States, in fact, held up the public airing of disputes as a good thing and a sign of a healthy relationship. Thus, Secretary of State Warren Christopher told an audience of Japanese business executives on March 11, 1994, about a meeting between President Clinton and Prime Minister Hosokawa the previous month. "For the first time," Christopher said, "an American President and a Japanese Prime Minister said in public that they could not agree in private. Both the President and the Prime Minister made a deliberate decision not to paper over our differences. The acknowledgment of that outcome was a welcome sign of a new candor in our relationship."(Note 6)

The biggest issue was autos and auto parts, which accounted for the bulk of the U.S. trade deficit with Japan. Before this issue was tackled, agreement had been reached on such other issues as Japanese Government procurement of goods as well as in financial services. During the negotiations on autos and auto parts, the United States threatened Japan with sanctions in the form of invoking Section 301 of the U.S. Trade Act, a move that would have amounted to a trade war. Fortunately, such a development was averted when the two sides reached an agreement, as most people agree that such a move on the part of the United States would have been a violation of GATT rules.

Interestingly, U.S. auto companies were not anxious for the United States to impose sanctions on Japanese car makers. This was because they and their Japanese counterparts are increasingly doing business together through joint ventures, a reflection of the symbiotic economic relationship that now binds the two countries. Even though the autos and auto parts dispute has been resolved, other issues remain to be settled, such as Kodak's complaint about unfair competition from Fuji Photo Film Company. New disputes, no doubt, are also likely to emerge.

Fortunately, there are now signs that the main issue between the two countriesCthe size of the U.S. trade deficitCis finally easing. According to preliminary Japanese figures, Japan's trade surplus with the U.S. stood at $45.6 billion in 1995, on a customs-clearance basis. While still the largest trade deficit, it is 17 percent less than the deficit of 1994, the first such drop in 5 years. Perhaps even more significant was the fact that Japan's global trade surplus shrank as well.

Moreover, month-on-month figures show a sharpening of the decline, with a drop in December 1995 of 35 per cent. If the decline continues, and analysts expect it to, this should lead to a much- needed easing of U.S.-Japan trade tensions. In fact, Japan now projects that its current-account surplus will drop to 2 per cent of its gross domestic product in the coming fiscal year, from more than 3 per cent a few years ago. If this happens, Japan will have reached a goal urged upon it by the United States some years ago. (Note 8)

Even before the release of the preliminary trade figures for 1995, the United States had indicated satisfaction with the general trend of U.S.-Japan economic relations. When the trade figures for October 1995 were released, showing a rise in the U.S. deficit with Japan for that month, Kantor said that he was not concerned because overall, U.S. exports to Japan are growing at three times the rate of imports from Japan.(Note 9)

Despite the highly publicized problems in the U.S.-Japan economic relationship, the two economies are increasingly dependent on one another. The United States is Japan's largest market, while Japan is America's second largest market after Canada, as well as the largest market for American agricultural products. At the same time, Japanese investments in the United States have resulted in the creation of several hundred thousand jobs as well as the introduction of Japanese management methods and technology.

The Japan-China Economic Relationship
Like the United States-China economic relationship, the Japan-China economic relationship was prevented from developing for political reasons during the 1950s and 1960s because Japan, following the lead of the United States, recognized the government on Taiwan as the Government of China. However, unlike the United States, which imposed a total trade embargo on China, the Japanese did manage to conduct a small trickle of private business in the 1950s, one that expanded somewhat after the Sino-Soviet split of 1959-60.

In the aftermath of the secret Kissinger visit to China of 1971 and the public one by President Nixon in 1972, when it became politically acceptable for Japan to establish diplomatic relations with China, Japan hastened to do so. While the United States maintained diplomatic relations with Taiwan for seven more years, until 1979, Japan immediately shut down its embassy in Taipei in 1972 and moved it to Beijing.(Note 10) As has been shown, the Japan-China relationship has been beset by political difficulties from the very beginning, and the legacy of the Japanese invasion of China in the 1930s and 1940s continues to haunt the two countries.

Establishment of diplomatic relations led to a sharp increase in economic activities, with Japan seeing China offering vast potential both as a supplier of raw materials and as a market for Japanese goods. The Japanese cemented their relations with China by signing a treaty of peace and friendship. The Japanese were, without doubt, the most active in China, penetrating into areas where few foreigners had been and erecting billboards advertising Japanese consumer products. The first modern store in Beijing's busy Wangfujing district was a Seiko outlet.

Japan and China had complementary interests. The Japanese, especially in the 1970s, were badly hit by the worldwide oil crisis and were looking for new sources of supply. The Chinese needed such things as finished steel and chemicals for their economic modernization program. This led to the signing of a long-term trade agreement between the two countries in 1978 under which Japan agreed to take $10 billion of oil and China would purchase Japanese plant and machinery.(Note 11) While implementation of the agreement did run into problems, the years since normalization of relations saw Japanese exports to China, primarily of capital goods, grow by leaps and bounds. Imports, primarily of raw materials such as coal, also rose. The trade was generally in Japan's favor, and by 1985, it generated a trade surplus of almost $6 billion.(Note 12)

In more recent years, however, while both Japan's exports to and imports from China have risen substantially, imports have outstripped exports, resulting in a trade balance in China's favor since 1988. A new trade agreement was signed in 1990, providing for China to provide crude oil and coal in return for Japanese technology and equipment. Latest figures show that in 1995, Japan-China trade totaled $57.85 billion, with China enjoying a large surplus of $14 billion.

While the relationship is mutually beneficial, it is still more important to China than to Japan. "side from Hong Kong, Japan has consistently been China's most important trading partner. For Japan, China has become the second-largest source of imports and the sixth largest recipient of Japanese imports.(Note 13)

However, while Japanese companies were eager to do business in China, they were cautious about investing, causing the Chinese to complain that Japan was not investing as much as it should and what investments there were tended to be in short-term, high-profit ventures such as hotels.(Note 14) Thus, Japanese investment in China in 1983 amounted to only $3 million. However, this trend changed in the mid-1980s, with investment reaching $100 million in 1985 and soaring to $1.2 billion in 1987. Since 1992, Japanese investment in China has exceeded $1 billion each year.(Note 15) One of the main reasons for this investment was to shift production from high-cost Japan to low-cost China. Japanese economists estimated that labor costs in China in 1988 were only about 10 per cent of labor costs in Japan.(Note 16) In addition, by sourcing production outside Japan, Tokyo would also reduce the amount of its exports to the United States Both Japan and the United States have increased their investments in China. The United States invested $2.1 billion in China in 1993, outstripping Japan's investment by 60 per cent. But, to keep things in perspective, it must be pointed out that the combined Japanese and American investments in China are dwarfed by investments from Hong Kong, which put $17.3 billion into China in 1993.

China's policy of absorbing foreign investment was reiterated recently when an official of the China Association of Foreign-Funded Enterprises announced that China planned to use $30 billion in foreign direct investment each year in the coming years, with $37.7 billion having been used in 1995.(Note 17) The trend toward greater Japanese investments in China reflects to a large extent the growing strength of the yen, which in the 1980s made Japan the world's main supplier of capital. Thus, in 1993, when the value of the yen jumped, Japan increased its direct investment in China by 58 per cent, to $1.69 billion. In the first half of the 1994 fiscal year, it rose by another 63.5 per cent.(Note 18) The rise in the yen's value, initiated to stimulate American exports, brought China an investment windfall, a sign of the increasing globalization of the world economy.

In the aftermath of the Tiananmen Square crackdown, Japan, like the United States, imposed economic sanctions on China. However, this was widely seen as a reflection of Japan's desire to keep in step with the United States rather than anything else. This, too, was the Chinese interpretation, with Premier Li Peng saying he could understand Tokyo's difficulty because of its relationship with the United States(Note 19) In any event, Japan became the first of the G7 nations to lift its sanctions against China, with the Japanese informing their partners at their July 1990 meeting in Houston that Tokyo would go ahead with a $5.2 billion loan to China, which had been suspended in 1989. Japan is by far the largest giver of aid in the world, and aid, in the form of long-term, low-interest loans, is much appreciated by China. Total loans to China from the Japanese Export-Import Bank are expected to reach $10 billion between 1993 and 1998.(Note 20)

Trilateral Economic Relations
The discussions of the three sets of bilateral relations shows that each bilateral relationship impacts on the others. Thus, the imbalance in United States-Japan trade forced a revaluation of the yen, which then caused Japanese companies to invest in China and elsewhere in Asia in order to cut costs. Factories set up by the Japanese in Asia create demands for materials and parts from Japan and, often, export products back to Japan, thus stimulating bilateral trade.

Similarly, when the United States threatens to impose sanctions on China, it affects China's relations with Japan as well as Europe. Unilateral sanctions by the United States are ineffective, because China will be able to obtain what it wants from Japan or Europe. Even in the absence of sanctions, China is able to shop around and play off an American supplier against a Japanese or European one. This is because, in the absence of a monopoly, an importer like China is able to shop around and look for the best bargain it can get. Unless there is a scarcity of goods, it is sellers, not buyers, who have to compete.

It has often been remarked that, in the post-Cold War world, geopolitics has been replaced by geoeconomics. Military power is still important, but economic problems do not lend themselves to military solutions. The United States and Japan, being the world's two biggest economies, have much in common and are increasingly interdependent. Threats of American sanctions, against China as well as Japan, have become less and less credible as the three countries' economies have become interwoven. A recession in the United States adversely affects Japan and China, at the least by reducing the market for their goods. Similarly, the United States has been at pains to advise Japan on how to revitalize its economy so that it can in turn absorb more American products and stimulate the American economy.

The Role of Multilateral Economic Organizations:

A Device for Deep Engagement of China?

Akio Watanabe

ONE OF THE MOST CHALLENGING TASKS FOR THE CREATION OF A post-Cold War international political and economic system is to integrate the two former socialist giants, Russia and China, well into that system.(Note 1) This is not to say that the old enmity of the Cold War era still dies hard so that we cannot move forward. Rather it is the very nature of these two great nations that creates the problem and makes integration a difficult task. Both the Russians and the Chinese have unique political and cultural traditions with deep roots in history. Both have big potentialities and embrace huge territories and populations. Despite these factors of greatness, or rather because of them, both nations have experienced serious difficulties in the process of adjusting to the needs of modern times, and socialist experiments were conducted as an attempt to solve their problems. Although significant achievements were reached though such experiments, their basic problems of adjustment still remain half-solved at best and in a sense were made more intricate because of the prolonged international isolation they suffered during the Cold War.

Akio Watanabe is Professor, School of International Politics, Economics and Business, Aoyama Gakuin University. He has written numerous publications in English, including his most recent, The Global Trend Toward Regional Integration.

The end of the Cold War means for all of us the beginning of an era characterized by a series of entirely new agenda. More specifically, for both Russia and China, their leaders are now facing historical tasks of political and economic reforms, each of which is guided by the concept of democracy and of market, respectively. They have been thus struggling to cope with the necessities of "modernization" or perestroika in recent years.

It seems that there is a basic agreement between the countries of advanced economy (led by G-7) on the one hand, and the leading two nations of the former socialist camp (Russia and China) on the other. The former group of countries is interested in accommodating the latter group into a broader network of international interdependence, both politically and economically. Their strategy is known by different names, most famous among which is "deep engagement." As for Russia and China, their leaders also seem to be interested in adapting their nations to the norms of international society, assuming that they have more to gain from participating in the network of international interdependence, while being rather cautious understandably about the degree and nature of inevitable costs of adjustment.

There is a sharp contrast between Russia and China, however, in their respective strategies of adaptation. While Russian leaders put political reforms (democratization) before economic restructuring (transformation of command economy into market economy), the Chinese counterparts have adopted economic modernization as afirst strategy. This difference between Russia and China is reflected also in the manner in which the respective countries have been so far incorporated into multilateral organizations. China is ahead of Russia in the participation in keystone international economic organizations (KIEO).(Note 2) The People's Republic of China (PRC) entered the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IRBD, or World Bank) in 1980, and in 1986 it formally requested that negotiations be started about its participation in the General Agreement on Tariffs and Trade (GATT). The Soviet Union (Russia), which participated in the Bretton Woods Conference, decided not to join the IMF and the World Bank. The Soviet participation in the KIEOs became a lively issue in Moscow only in the late 1980s, apparently inspired by the Chinese example. Russia, as successor to the Soviet Union, is now a member of the IMF and the World Bank but it has not yet opened negotiations for participation in GATT/WTO. This difference is a reflection of the difference in the degree of each nation's actual involvement in economic interdependence with major market economies of which we will see later. Suffice it to say here that China is significantly ahead of Russia in terms of ecomomic integration.

Russia has obtained a clear advantage, however, in the political arena by associating itself with a group of democratic societies that are on the whole more sympathetic toward Mosocow than toward Beijing. An irony is that the G-7, an exclusive club of advanced economies and therefore an economic grouping in its nature, has invited Russia to the summit as a guest, if not full-fledged member. This was apparently an act of political gesture with a view to encouraging democratic reforms in Moscow rather than recognition by the G-7 countries of Moscow's economic performance.

In the United Nations, a multilateral political organization that has a virtually universal membership, Russia and the PRC are given permanent seats at the Security Council, a legacy of World War II. The former Axis powers, notably Germany and Japan, are still prevented from gaining such privileged positions in the United Nations, while they have been integrated into the global market economy and become leading members of the KIEOs during the past half century.

Thus anomaly exists in the structures of international political and economic organizations. In order for these organizations to be viable in the next century, it would be necessary to integrate the two economic giants (Germany and Japan) into the U.N. Security Council and to incorporate the two former socialist giants into the international network of economic interdependence. These two tasks have their own difficulties and need to be addressed separately, although they are interrelated in the depth from the viewpoint of global governance that is suitable for the needs of the coming century. Hence the need to address one of the above-mentioned two aspects (i.e., economic aspect) of institutional questions, focusing on the Chinese component and referring to Russia only tangentially for the purpose of comparison.

Before proceeding to the substance, one more general remark is worthwhile about regional vs. global mechanisms. In the post Cold-War context, two levels of institutional developments have been underway: global and regional levels. At the global level, efforts have been extended to revitalize and restructure the United Nations especially in the field of international peace and security. 3 Likewise, the KIEOs are facing some problems of renovation so that they could better cope with the new realities. The inclusion of Russia and China falls under this category as alluded before. At the regional level what are worth mentioning here are the Asia Pacific Economic Cooperation (APEC) and the ASEAN Regional Forum (ARF) in Asia and the European Union (EU) and NATO in Europe. Regional approach has both advantages and. On the positive side, one can cite an economy of transaction cost, namely the relative ease with which schemes for international cooperation can be worked out because of the smaller size of membership. A pitfall exists, howeverCit can turn out to be a device for isolationism in disguise and as such may lead to inter-regional rivalry of a destructive nature. Careful attention is therefore needed to make it sure that regional cooperation is compatible, not antagonistic, with global cooperation.

Both China and Russia have distinctive problems of their own in their relations with the regional organizations. The sheer size is a problem common to them because it makes their place in any regional organization uneasy and intractable. (This is, incidentally, also a problem for Japan and the Unites States). Comparatively speaking, however, China seems ahead of Russia in the degree of regional (especially economic) integration. China has joined the APEC while Russia is still outside any regional economic organizations of importance either in Asia or in Europe. It is difficult to make any definite predictions about the way in which these two powers are incorporated into regional security mechanisms. The emergence of security community encompassing Russia and China on the one hand, and the U.S. allies on the other, seems still in a distant future.

Despite substantial progress that has made during the past decade or so, the historic task of integrating the two socialist giants firmly into a broader network of international economic and security interdependence is obviously far from completion. If any of the major actors (especially China, Japan, and the United States) have no objection to the long-term goal of world peace and prosperity, the strategy of interdependence should be the common language for them. Even then, the path to that goal cannot be always easy as fully demonstrated by our experiences in the recent past. To have a better understanding of the problems standing in the way, let us pursue the subject in more details focusing on China's participation in GATT/WTO and the role of APEC.

China and GATT/WTO
China stopped castigating GATT4 and its sister institutions of the KIEOs as mechanisms to facilitate imperialist exploitation and domination of the world economy in 1978, when its leaders abandoned their traditional policy of a self-sufficient national economy. This reorientation of China's foreign economic policy was part of its "four programs of modernization." It took only 2 years for China to be admitted to the IMF and the World Bank. Compared with the relatively smooth process of China's engagement with the above two pillar organizations of the KIEOs, its path to the third pillar, GATT, has been more eventful and, as of today, still unfinished.

In July 1981 China was received as an observer at a GATT meeting dealing with the renewal of the Multifibre Arrangement (MFA), an arrangement under the GATT system concerning textile trade. In December 1983, China obtained a full membership in GATT's MFA. The expected merits for China of its participation in this arrangement included an easier access to markets in advanced economies (China was already a major textile exporter ) and improved familiarity with GATT procedures. Its participation in MFA can be regarded as a prelude to China's engagement with the GATT itself.

In the meantime, many significant changes were introduced in China's foreign trade and its institutions and practices concerning foreign economic policy. China's trade strategy changed from autarky to a kind of import substitution, bringing about a sharp increase in its export earnings (whose average annual growth rate during the 8 years after 1978 doubled that of previous 19 years). Its foreign trade turnover increased from U.S. $14.80 billions in 1977 (the year immediately preceding to the commencement of open door policy of China) to U.S. $73.80 billions in 1986.(Note 5) China's trade pattern also showed a dramatic change in terms of geographical distribution. In the period of autarky its major trading partners were countries of planned economies (which accounted for as much as 70 percent of its trade in 1953, for example). During the 1980s, about 85 percent of China's exports went to the contracting parties of GATT, and more than 90 percent of its imports were from the same group of countries. (Note 6)

The rapidly expanding trade with the contracting parties of GATT went along naturally with the increased importance in the policy-making machinery in Beijing of those officials who were familiar with and sympathetic for foreign trade in general and GATT procedures in particular. They were led by, among others, Hu Yaobang and Zhao Ziyang.

It was under these circumstances that interaction between Chinese and GATT officials began to take place vigorously. Ake Linden, legal adviser to the director-general of GATT, and Arthur Dunkel, the director-general, himself made visits to Chinese capital in 1984, 1985, and 1986. Then on 14 July 1986 the PRC Government officially notified GATT of its decision to seek the resumption of its status as a contracting party.(Note 7)

The initial negotiations proceeded rather smoothly until they were abruptly terminated in the summer of 1989, as shown in the following brief chronology:

    

February 1987	PRC submitted a memorandum describing its

		 foreign trade regime

May 1987	GATT established a working party 

		      (a) to examine the PRC's foreign trade regime, 

		      (b) to prepare a protocol setting forth China's rights

		      and obligations in GATT, and

		      (c)to address other issues concerning China and GATT.

February 1988	Working party held six sessions to review the to 

		July 1989   PRC's memorandum. Oral and written 

		questions were submitted by contracting parties 

		(mostly by the United States, the European 

		Community and Japan) to which PRC responded 

		orally or in written submissions.

In parallel with the multilateral negotiations on the table of the working party, a series of bilateral discussions were underway in which the three major trading partners with PRC-the United States, the EU and Japan-played a leading role. These big three absorbed about one-third of PRC exports and more than half of the latter's imports were from the big three in the 1987 trade statistics (if Hong Kong is added, the figures rise to 68.7 and 70.8 percent, respectively). All these major trading partners were interested in bringing China into full participation in the GATT, believing that, given the already significant involvement of China in the world economy, it would not make sense to leave the PRC outside the GATT for long. No serious objections were heard either from the smaller economies of the advanced nations (OECD) or from the developing nations (G-77), although some members of the latter group were warily watching lest any precedents were to be established in the agreement between the PRC and the GATT that might affect them (like the concept of "graduation").

The negotiations over the PRC's participation in the GATT were being conducted under the generally favorable conditions as far as the international environments were concerned. Nevertheless, it was expected from the onset that the negotiations would be difficult and long, because the GATT was designed in principle for dealing with relations among market economies and many special issues related to nonmarket economies like the PRC would have to be addressed before it was admitted to the GATT. What is more, the contracting parties would have to take more cautious approach to PRC accession than when some of the Eastern European countries were admitted to the GATT in the earlier times, simply because its possible impacts, either positive or negative, on the international trade regime would be much greater than those smaller socialist economies. While political considerations were dominant in the case of Eastern Europeans' accession, the negotiations about China would be guided by forthright commercial interests of the contracting parties.

From the PRC viewpoint, weighing expected benefits against accompanying costs was a very serious undertaking. The PRC had to satisfy certain conditions (such as release of data on its economic performance) that were required for participation in the IMF and the World Bank. What was required of China for accession to the GATT was much more ramified and more penetrating, bearing more directly on the very nature of its economic system. In short, China would be requested to move more boldly toward a truly market-type economic system. "lternately, it would have to give some special concessions (such as "selective safeguard," explained later) to the contracting parties to compensate for the defects as a market economy. In either case, PRC leaders would be required to accept more serious political costs to enter the GATT than in the previous cases of its accession to the IMF and the World Bank. Thus the fate of the negotiations over China's entry into the international trade regime was to depend to a great extent upon the domestic politics of China.

In view of the salience of the GATT-related issues in Chinese domestic politics, the negotiation about PRC accession to the GATT was destined to be a typical case of "double-edged diplomacy " or "two-level game."(Note 9) The final results of the negotiations would be determined by a complicated interplay between (a) bargaining on the international level (i.e. multilateral negotiations at the working party and a series of bilateral discussions between individual contracting parties and the PRC) on the one hand and (b) bargaining among different political actors on the domestic level (in China as well as in the United States and other interested parties). The scope of negotiated settlement would vary depending on the political games on level one (international bargaining) as well as on level two (domestic bargaining). If the hardliners gained ground in the games at any of these two levels or both, the scope of negotiated settlement (which the originators of the two-level game model call "win-sets") would become smaller, and if gone to the extreme, no agreement would be possible.

The Tiananmen incident in the summer of 1989 had tremendous impact on the politics of the GATT-PRC negotiations by narrowing the "win-sets" both in the United States and in China. In the United States, the trade politics (i.e., most-favored-nation status for China) became inextricably linked with the human rights issue. By a curious coincidence, the image of a democratic Russia began to loom about this time, which brought about an unmistakable shift of the U.S. China policy, which had been until then clearly characterized by "preoccupation with the potential security dimension of the bilateral relationship."(Note 10) Now that the perceived threat from the Soviet was gone, the importance of China could no longer be defined as military but as economic. The advent of a new Democratic Administration in 1992, with the slogan, "It's the economy, stupid," only fostered this shift in U.S. China policy.

The impact of the incident on Chinese politics was more direct and severe. Zhao Ziyang was ousted from the government and the pro-GATT officials found themselves placed in an awkward position. The strained relations with the United States only helped to bolster the ideologically oriented hardliners in Beijing.

It is true that, in purely legalistic terms, the MFN issue has nothing to do with the issue of China's accession to GATT, because the question of renewal of MFN status for China is a matter of domestic law of the United States. Imports from countries with MFN status are levied at the lowest tariff rates applied to imports into any contracting party to GATT, that is, rates negotiated within the framework of the GATT. However, the United States has a domestic law which makes granting MFN status contingent upon certain conditions. The MFN status is subject to annual renewal by the president in accordance with the Jackson-Vanek Amendment to the Trade Act of 1974. Under this law, MFN status together with some other benefits are linked to emigration policies for those nonmarket economies that did not already enjoy MFN status at the time this law was enacted. Legalistic interpretations apart, however, it was inevitable that under the existing political circumstances the MFN status issue became inevitably mixed up with the negotiations over PRC participation in the GATT.(Note 11)

The negotiations were suspended in the summer of 1989 and resumed in the autumn of 1992.(Note 12) Major points at issue had not changed before and after the intermission. According to Assistant U.S. Trade Representative Douglas Newkirk, the discussions were underway as of March 1993 (about 6 months after the resumption) over the following five points:

Despite the seeming continuity over the time of the substantial content of the discussions on the table of the U.S.-PRC negotiations, there were important changes in the surrounding atmosphere and in membership of the negotiating team on the Chinese side when the negotiations restarted. According to the U.S. negotiator,

The negotiations in 1989 ended at the end of May 1989, in Beijing, when my delegation and I left. Two days later there was Tiananmen Square. That, in effect, ended our negotiations. Enough time had passed between then and when we restarted that we had a new negotiator on the Chinese side. They had felt that there had been major advances in their reform, and they had a different perspective of what they should or shouldn't do. Our position hadn't changed. We still wanted the same five points, modified to reflect the changes that had taken place since then.(Note 16)

The political fever about the GATT in Beijing rose very high in 1992-93 in anticipating and then following the restarting of the bilateral negotiations with the United States. Numerous books and pamphlets on that subject mushroomed during those months.(Note 17) The fever began abating, however, around mid-1994. The immediate reason for that was probably the Clinton administration's decision in June 1994 to separate the issue of MFN status from the human rights question. Also the Chinese hope of being present at the creation of the WTO, successor to the GATT, began to look faint, thus bringing the fever under. Conversely, the Chinese began to become more seriously committed to the APEC (Asia Pacific Economic Cooperation). Since most of China's major trading partners are members of this regional economic organization, China did not have any particularly urgent reason to get into the GATT/WTO at presumably high costs, as long as they could enjoy good relations with APEC members.(Note 18)

THE ROLE OF REGIONAL ORGANIZATIONS
The APEC is at this moment comprises 18 members whose total GDP amounted to U.S. $13,400 billion (or 56 percent of the world total) . Their total volume of trade amounted to U.S. $3,400 billion (46 percent of the world total). The United States, Japan, and China are the three largest national economies; their respective shares of GDP were 30.2, 17.6, and 2.3 percent and those of the trade volume were 19.9, 8.1, and 2.6 percent. In terms of per capita GDP, however, there was a big gap between the Japan and the United States on the one hand, and China on the other; Japan (U.S.$33,700) and the United States (U.S. $24,400) were the highest two, and China (US$ 452) was among the lowest (all these figures are as of 1993).

Respective Shares (%) of Exports Among the Three Major Economies in APEC



 Year      China/US        China/Japan       US/China         US/Japan  

 1980         1.7             	9.4         	5.4         	22.2
 1985         1.8            	10.6         	8.5         	22.3
 1990         1.2            	12.4         	8.5          	14.6
 1994         1.8            	10.4       	17.7        	17.8

  Year      Japan/China      Japan/US  

  1980        3.9             	24.5

  1985        7.1             	37.6

  1990        2.1             	31.7

  1994        4.7             	30.0

(Legend: A/B indicates exports from A to B. The figures in each column mean that percentage of the total exports of A in the given year went to B)(Note 19) Based on the figures shown above, we can make the following observations:

Some experts cast doubts about the prospects of Asian economies but if we subscribe to more common views, we can assume that non-Japanese East Asian economies will continue to expand probably at least for another decade.(Note 20) Even if the pace of growth of East Asian economies will become somewhat slower, the trend towards an increasing economic interdependence among the United States, Japan, and East Asia (China included) is unlikely to disappear. Interdependence means that each of the actors involved is sensitive and vulnerable to each other. That means in turn that everybody tends to be cautious not to be adversely affected by irresponsible and disruptive behavior of other members. International institutions and regimes are expected to foster cooperative behavior among the members and to prevent defectors by setting common rules, norms and codes of conduct. The rationale for the regimes is stated by well-known experts on the subject as "such adjustment and coordination can be achieved through coercion only at great cost; striving for consensus is much more attractive."(Note 21)

The GATT/WTO is an example of such regimes. It is basically run by consensus. As compared to the APEC, however, the GATT/WTO is harder in the sense that it is more legalistic. A soft and less legalistic regime like the present APEC is more congenial to most of the Asian members of the APEC. This applies to China also because Chinese are said to have a "deep preference for dialogue rather than conditionality, for persuasion rather than imposition of demands."(Note 22) Although the APEC has its own limitations both in geographical and functional scope and therefore cannot be a perfect substitute for the WTO, it has a potential advantage as a device of "deep or constructive engagement" of China.

The Osaka meeting of the APEC in November 1995 adopted a document entitled, "The Osaka Action Agenda: Implementation of the Bogor Declaration." The participating members pledged that their governments would "immediately begin the preparation of concrete and substantive Action Plans to be submitted to the 1966 Ministerial Meeting in the Philippines for assessment." They brought a package of initial actions (known also as "down payment") to demonstrate their "firm commitment to achieving liberalization and facilitation" of international trade as was promised in Bogor in 1994. Down payment of the PRC included its promise to "slash substantially the tariff on over 4,000 tariff lines. The reduction of the simple average tariff will be no less than 30 percent." Elimination of the quota, licensing and other import control measures on about 170 tariff lines, accounting for over 30 percent of the commodities now subject to import quota and licensing requirement was also promised to be achieved in 1996.(Note 23)

The APEC style of multilateral coordination/adjustment is termed as "concerted unilateral actions," which rely on voluntary cooperation, confidence-building measures, and peer pressure rather than on hard-nosed negotiations and binding laws. Most of Asian observers, including the Japanese, have expressed their preference for a soft approach like this.(Note 24) Some even go on to argue that American style of legalistic negotiations, more often than the difference in values and interests, is the source of conflict between the United States and its Asian partners.(Note 25) This style of soft regime may easily turn out to be a mere talking shop and cannot be always reliable. But it may well be an apt mechanism for the purpose of fostring mutual adjustment between China and its partners in the Asia-Pacific.(Note 26)

Another merit of APEC is that it is unlike GATT/WTO, which is simply trade oriented and multifunctional and covers a broad range of issues, including noneconomic matters. "The annual informal APEC summit meeting will provide an overall framework for regional confidence building and cooperation. The APEC leaders meeting can be an excellent forum for putting pressure on a country that deviates from the established 'code of conduct'. In this regard, the annual summit meeting has important political and secuirty implications as well as economic ones."(Note 27) President Clinton should be commended for his initiative in starting informal annual summit of APEC.(Note 28)

There is no serious disagreement between the United States and Japan on the multilateral economic organizations like the GATT/WTO and APEC. Both are clearly interested in bringing China into a broader network of economic and security interdependence. Japan is inclined, however, to a softer approach that the United States. Unlike the United States, Japan cannot afford to have recourse to unilateral sanctions (such as the Jackson-Vanek Amendment). Japan has no tradition of linking issues of foreign economic policy to political and security issues. Rather, it has been known for its characteristic approach of "separation of economics from politics" (seikei buniri). It also tends more often than not to pay respect for Chinese aversion to overt pressure from outside.

As is the case with many other instances, an apt mixture of "sticks and carrots" is the best strategy. It would not be fair, however, for Japan to use carrots only, always relying on the sticks used by the United States. It would not be very easy to find a proper division of labor between the United States and Japan.

A final and most important point is that an international regime, be it regional and soft (like APEC) or global and hard (like GATT/WTO), is not a panacea. As Jacobson and Oksenberg said, "continued perception of the convergence of strategic interests among Washington, Tokyo, Beijing, and the EEC capitals is probably necessary to encourage all the countries involved to make the necessary and difficult compromises looming ahead."(Note 29) This is certainly the crux of the whole matter. Nothing but a robust and far-seeing statesmanship can solve it.

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