US China Commission Report Says ‘Engagement’ Not Working Too Well

While President Biden just met Chairman Xi Jinping in San Francisco and the White House is touting yet another “agreement” between the U.S. and China, the U.S. China Economic and Security Review Commission released its annual report that provides a sobering reality check. For those cheerleading another meaningless agreement that China will “promise” to adhere to, the Commission lays out the facts and sets the record straight.

From CPA’s perspective, China’s Communist Party (CCP) regime has given no sign of altering its policies, either at home or abroad. Beijing continues to reject cooperation with the United States on fundamental questions of national security, economics or trade. None of the flurry of visits and other diplomacy over the past year have resulted in any significant change of course by the regime. The result of high-level meetings between the United States and China has been merely the promise of further meetings—that is, of more talk, rather than concrete actions. China now appears to view diplomacy with the United States primarily as a tool for forestalling and delaying U.S. pressure over a period of years while China moves ever further down the path of developing its own economic, military and technological capabilities. Beijing, in a continuing and deepening effort to challenge the existing international order, seeks to create a new one that will be aligned against the United States.

From the Commission’s view, their massive 753 page report to Congress on Tuesday noted that the bilateral trade relationship is changing fast, and supply chains are moving to Asia as a result. But the problem is that most of those supply shifts are still in the hands of Chinese companies that have simply set up shop in countries like Vietnam, or have hired contractors there instead.

From the report’s Executive Summary: “The composition of U.S.-China bilateral trade has changed dramatically in the last five years, owing to U.S. tariffs imposed under the Trump Administration Section 301 investigations, an increasingly uncertain business environment inside China, and other policy initiatives and efforts. Although China dismantled the Covid-19 controls that had sent its economy into unpredictable lockdowns throughout 2022, U.S. businesses and investors are reassessing the stability of China’s domestic policy environment. Many of the U.S. industries exposed to trade actions and geopolitical tensions have begun to shift toward suppliers in other parts of Asia. Frequently, however, these suppliers are Chinese companies with overseas operations, and U.S. supply chain exposure remains at risk as Chinese producers expand their presence in regional supply chains,” the Commissioners wrote. 

The Commission said this was particularly true with clean energy technologies, citing China’s pole position as a top EV battery producer now, competing head to head with Japanese and South Korean companies who were early entrants. 

Over the years, China has outsourced, or built manufacturing facilities in Southeast Asia to manufacture solar panels for export to the U.S. China is the world’s largest solar manufacturer, an energy technology the U.S. is seeking to replace fossil fuels.

Some of the key findings from the report about trade relations that could be used by either side in the ongoing, and often heated debate about China, include:

• On export restrictions of advanced technologies to China: The restrictions led to a drop in U.S. semiconductor exports of 50.7 percent in the first eight months of 2023 relative to the same period in 2022—down to $3.1 billion from $6.4 billion the year prior. The controls prompted China to increase efforts to draw foreign talent to its chip industry, circumvent export controls, expand espionage activities, and promote indigenous innovation.

• On Section 301 tariffs and supply chain shifts: Many of the U.S. industries exposed to trade actions and geopolitical tensions shifted toward suppliers outside of China, but this may not reduce U.S. reliance on Chinese manufacturing. A growing portion of suppliers in overseas markets are owned by Chinese companies who also seek to evade trade restrictions by setting up facilities overseas that can then import parts that would be tariffed if shipped to the U.S. 

• On companies rethinking China risk: Amid heightened geopolitical tensions, U.S. businesses frequently found their Chinese operations getting caught in the crosshairs of Chinese restrictions. While many U.S. firms continue to view access to China’s market as crucial to growth, a growing number of them are moving to limit exposure and identify alternative strategies. Vanguard recently exited its partnership with Ant Financial, the financial arm of the Alibaba Group of companies created by Chinese billionaire Jack Ma. Apple is said to be shifting some production of its cell phones and accessories to India.

Read the September CPA report by our economics team on job losses per metro area due to outsourcing manufacturing to China.

Reshoring vs Derisking

Reshoring is the preferred outcome of the Section 301s, and while that has happened in some sectors studied by the International Trade Commission in a report released in March, the buzzword on Capitol Hill and in the C-suites is “derisking”.  Derisking is happening, the Commission said, garnering from dozens of interviews with executives around the country.

“U.S. corporations are actively seeking strategies to mitigate risks in their supply chains, prompted by their demonstrated vulnerability to policy and market shifts in China,” report authors wrote. “U.S. businesses frequently found their Chinese operations getting caught up in the crosshairs of new Chinese restrictions,” the Commission authors said, due to geopolitical tensions.

The shrinking deficit with China can be seen as evidence of derisking, meaning supply chains are leaving the mainland. 

The U.S. goods trade deficit with China fell to its lowest reading since 2020, when the pandemic began. According to U.S. Census calculations, the U.S. trade deficit with China in the year through August 2023 shrank 33 percent compared to the same period in 2022, falling to $181.8 billion. This is the lowest trade deficit with China since 2010. 

The improvement in the trade deficit resulted from a softening of U.S. import demand that began in September 2022 as U.S. consumers shifted spending toward services. However, U.S. data on trade with China may currently overstate the improvement in the bilateral balance. Particularly, U.S. statistical authorities may not capture the full value of China’s imports into the United States, partially due to a lack of data on the tens of billions of dollars’ worth of low-price goods that enter duty-free under the de minimis exception, as CPA’s chief economist Jeff Ferry wrote about in a report last year, and in op-ed that ran in MarketWatch in February 2022.

“De minimis is a vector not only for products emanating from the Xinjiang region, whether it’s textile or other products; there have been a number of studies across a number of supply chains—solar, aluminum, car parts, but fentanyl is also coming in through the de minimis loophole,” Commission Michael Wessel said. “The administration has the legal power to act. There needs to be something done.”

Data reported by China’s customs authority show a larger surplus with the United States at $206.4 billion in the first eight months of the year, though Chinese statistics also show a substantial 17.4 percent decline relative to the same period in 2022, according to the Commission report. 

U.S. goods imports from China totaled just $276 billion in the first eight months of 2023, falling $92.5 billion behind the pace of imports over the same period in 2022.

U.S. imports from China are on track to decline compared to 2022, when they reached $536.3 billion, the highest level since the onset of the trade war in 2018.

Some Commission Advice & Vietnam as China’s ‘Mini-Me.’

The report also highlighted a number of minerals the U.S. will need to build out its post-fossil fuels economy and semiconductor industry. And gave Congress 30 recommendations for action in 2024. 

Some of those recommendations include:

• Legislation establishing a framework for corporate disclosure requirements to provide investors greater transparency into risks from publicly traded companies’ exposure to China;

• Congress should request an evaluation, to be completed within 180 days by the General Accountability Office, of the effectiveness of export controls to see what is getting allowed for sale, and if the program is working;

• Asks that the U.S. Department of Education conduct a study on the average amount of foreign gifts and contracts received by universities and colleges to determine whether the threshold of $250,000 needs to be adjusted for programs in academic disciplines Congress deems critical to U.S. national security. The study should also include an analysis of the amount, focus, and potential impact of China gifts to schools, and research contracts awarded to U.S. universities and colleges over the last ten years; 

• Congress should establish a risk matrix framework to evaluate the national security threat posed by electronic products imported from China. To eliminate or mitigate risks identified in the threat matrix evaluation, Congress should consider the use of all trade tools, including tariffs;

• The USTR began a review of the Section 301 tariffs in September 2022 and they could conclude by the end of the year. While the details of the review are not yet known, in July 2023 the USTR stated the review will consider “the existing tariffs structure and how to make the tariffs more strategic in light of impacts on sectors of the U.S. economy as well as the goal of increasing domestic manufacturing.” Treasury Secretary Janet Yellen earlier this year called the tariffs a “point of leverage” as the United States seeks to address China’s “unfair trade practices,” stating that “it’s premature to use this as an area for de-escalation, at least at this time.”

The Biden Administration has sought closer ties to China’s region of the world through the Indo-Pacific Economic Framework, which includes members like Vietnam, in order to build a counterweight to China’s growing influence there, they argue. 

Commerce is currently considering removing Vietnam from its list of non-market economies, of which China is a part. Vietnam is the only Southeast Asian “tiger” that is still considered a non-market economy. Some 25% to 30% of its GDP is reliant on state owned enterprises, which is on par with that of the Chinese economy. And while the Commission report does not single out Vietnam as a China outsourcing partner, it does say that derisking has led to supply chain shifts in Asia, of which Vietnam is a dominant player in this case.

In September, President Biden met with Vietnam’s General Secretary Nguyen Phu Trong in Hanoi to establish a comprehensive strategic partnership, which is setting the table for Vietnam to lose its non-market status. 

According to the Commission, the Biden Administration “wants to develop trade partners outside of China by furthering U.S-Vietnamese economic cooperation, including efforts to enhance semiconductor supply chain resilience by building capacity in both countries.” It is unclear, however, the extent to which developing trade relations with Vietnam will remove China from U.S. supply chains, the Commission warned.

Following the end of China’s disastrous Zero-Covid policy, Chinese firms began moving production to other countries in Southeast Asia. Vietnamese government data report Chinese firms invested in 45 new projects in the country in the first 50 days of 2023 alone. In addition, nearly one-third of Vietnam’s imports come from China, such as solar cells used in making solar panels for export to the United States. 

“China’s deep trade and investment relations with Vietnam complicate U.S. de-risking efforts,” the Commission report authors wrote. U.S. business deals with Vietnamese partners “may still ultimately depend upon Chinese companies and imports.”

Job Loss by Metro Area Shows Devastation from China Shock