Order Code IB98014
CRS Issue Brief for Congress
Received through the CRS Web
China’s Economic Conditions
Updated May 15, 2006
Wayne M. Morrison
Foreign Affairs, Defense, and Trade Division
Congressional Research Service ˜ The Library of Congress

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CONTENTS
SUMMARY
MOST RECENT DEVELOPMENTS
BACKGROUND AND ANALYSIS
An Overview of China’s Economic Development
China’s Economy Prior to Reforms
The Introduction of Economic Reforms
China’s Economic Growth Since Reforms: 1979-2006
Causes of China’s Economic Growth
Measuring the Size of China’s Economy
Foreign Direct Investment in China
China’s Trade Patterns
China’s Major Trading Partners
Major Chinese Trade Commodities
Major Long-Term Challenges Facing the Chinese Economy
Outlook for China’s Economy and Implications for the United States

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China’s Economic Conditions
SUMMARY
Since the initiation of economic reforms
world’s third-largest trading economy after the
in 1979, China has become one of the world’s
United States and Germany. China’s trade
fastest-growing economies. From 1979 to
boom is largely the result of large inflows of
2005 China’s real GDP grew at an average
foreign direct investment (FDI) into China,
annual rate of 9.7%; it grew by 9.9% in 2005.
which totaled $60 billion in 2005. Over half
During the first quarter of 2006, China’s real
of China’s trade is accounted for by foreign-
GDP grew by 10.2%. Many economists
invested firms in China.
speculate that China could become the world’s
largest exporter within the next few years and
China’s economy continues to be a con-
the largest economy within a few decades,
cern to U.S. policymakers. On the one hand,
provided that the government is able to con-
China’s economic growth presents huge
tinue and deepen economic reforms, particu-
opportunities for U.S. exporters. On the other
larly in regard to its inefficient state-owned
hand, the surge in Chinese exports to the
enterprises (SOEs), the state banking system,
United States has put competitive pressures on
and fixed exchange rate system. In addition,
various U.S. industries. Many U.S. policy-
China faces several other difficult challenges,
makers have argued that greater efforts should
such as pollution and growing income in-
be made to pressure China to fully implement
equality, that threaten social stability.
its WTO commitments (especially in terms of
protecting U.S. intellectual property rights)
Trade continues to play a major role in
and change various economic policies deemed
China’s booming economy. In 2005, exports
harmful to U.S. economic interests, such as its
rose by 28.4% to $762 billion, while imports
currency policy and its use of subsidies to
grew by 17.6% to $660 billion, producing a
support its state-owned firms.
$102 billion trade surplus. China is now the
Congressional Research Service ˜ The Library of Congress

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MOST RECENT DEVELOPMENTS
On May 10, 2006, the Treasury Department issued its semi-annual report on exchange
rate policies. The report stated that while China had moved too slowly in making its
exchange rate regime more flexible, it would not be designated as a country that manipulates
its currency. On May 15, China’s currency appreciated to 7.9982 yuan per dollar, the highest
level since the currency was reformed in July 2005.
On April 16, 2006, China announced that GDP had risen by 10.2%, and that it had
$23.3 billion trade surplus, during the first quarter of 2006.
On April 14, 2006, China announced that its foreign exchange reserves reached $875
billion at the end of March 2006. China overtook Japan in February 2006 as the world’s
largest holder of foreign exchange reserves.
BACKGROUND AND ANALYSIS
An Overview of China’s Economic Development
China’s Economy Prior to Reforms
Prior to 1979, China maintained a centrally planned, or command, economy. A large
share of the country’s economic output was directed and controlled by the state, which set
production goals, controlled prices, and allocated resources throughout most of the economy.
During the 1950s, all of China’s individual household farms were collectivized into large
communes. To support rapid industrialization, the central government undertook large-scale
investments in physical and human capital during the 1960s and 1970s. As a result, by 1978
nearly three-fourths of industrial production was produced by centrally controlled state-
owned enterprises according to centrally planned output targets. Private enterprises and
foreign-invested firms were nearly nonexistent. A central goal of the Chinese government
was to make China’s economy relatively self-sufficient. Foreign trade was generally limited
to obtaining only those goods that could not be made or obtained in China.
Government policies kept the Chinese economy relatively stagnant and inefficient,
mainly because there were few profit incentives for firms and farmers; competition was
virtually nonexistent, and price and production controls caused widespread distortions in the
economy. Chinese living standards were substantially lower than those of many other
developing countries. The Chinese government hoped that gradual reform would
significantly increase economic growth and raise living standards.
The Introduction of Economic Reforms
Beginning in 1979, China launched several economic reforms. The central government
initiated price and ownership incentives for farmers, which enabled them to sell a portion of
their crops on the free market. In addition, the government established four special economic
zones along the coast for the purpose of attracting foreign investment, boosting exports, and
importing high technology products into China. Additional reforms, which followed in
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stages, sought to decentralize economic policymaking in several sectors, especially trade.
Economic control of various enterprises was given to provincial and local governments,
which were generally allowed to operate and compete on free market principles, rather than
under the direction and guidance of state planning. Additional coastal regions and cities
were designated as open cities and development zones, which allowed them to experiment
with free market reforms and to offer tax and trade incentives to attract foreign investment.
In addition, state price controls on a wide range of products were gradually eliminated.
China’s Economic Growth Since Reforms: 1979-2006
Since the introduction of economic reforms, China’s economy has grown substantially
faster than during the pre-reform period (see Table 1).1 From 1960 to 1978, real annual
GDP growth was estimated at 5.3% (a figure many analysts claim is overestimated, based
on several economic disasters that befell the country during this time, such as the Great Leap
Forward and the Cultural Revolution). During the reform period (1979-the present), China’s
average annual real GDP grew by 9.7%; it grew by 9.9% in 2005. During the first quarter
of 2006, real GDP grew by 10.2% over the same period in 2005. Since economic reforms
were begun, the size of the economy in real terms has increased eleven-fold, and real per
capita GDP (a common measurement of living standards) has gone up eight-fold.
1 In January 2006, China made major revisions to its GDP data for 1993-2004. The revisions
indicated that, based on new estimates of growth in the service sector, the size of China’s economy
and its GDP growth were significantly higher than previously estimated. For example, real GDP
growth in 2004 had been originally measured at 9.5%, but the revised figure puts this rate at 10.1%,
and the overall size of the economy in 2004 was estimated to be nearly 17% bigger.
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Table 1. China’s Average Annual Real GDP Growth Rates, 1960-2006
Average annual
Time period
% growth
1960-1978 (pre-reform)
5.3
1979-2005 (post-reform)
9.7
1990
3.8
1991
9.3
1992
14.2
1993
14.0
1994
13.1
1995
10.9
1996
10.0
1997
9.3
1998 7.8
1999 7.6
2000
8.4
2001 8.3
2002 9.1
2003
10.0
2004 10.1
2005
9.9
2006 (first quarter)
10.2
Source: Official Chinese government data.
Causes of China’s Economic Growth
Economists generally attribute much of China’s rapid economic growth to two main
factors: large-scale capital investment (financed by large domestic savings and foreign
investment) and rapid productivity growth. These two factors appear to have gone together
hand in hand. Economic reforms led to higher efficiency in the economy, which boosted
output and increased resources for additional investment in the economy.
China has historically maintained a high rate of savings. When reforms were initiated
in 1979, domestic savings as a percentage of GDP stood at 32%. However, most Chinese
savings during this period were generated by the profits of state-owned enterprises (SOEs),
which were used by the central government for domestic investment. Economic reforms,
which included the decentralization of economic production, led to substantial growth in
Chinese household savings (these now account for half of Chinese domestic savings). As
a result, savings as a percentage of GDP has steadily risen; it reached nearly 50% in 2005,
among the highest savings rates in the world.2
2 In comparison, the U.S. savings rate was about 10% in 2005. Savings defined as aggregate
national savings by the public and private sector as a percentage of nominal GDP. (Economist
Intelligence Unit database.)
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Several economists have concluded that productivity gains (i.e., increases in efficiency
in which inputs are used) were another major factor in China’s rapid economic growth. The
improvements to productivity were caused largely by a reallocation of resources to more
productive uses, especially in sectors that were formerly heavily controlled by the central
government, such as agriculture, trade, and services. For example, agricultural reforms
boosted production, freeing workers to pursue employment in the more productive
manufacturing sector. China’s decentralization of the economy led to the rise of nonstate
enterprises, which tended to pursue more productive activities than the centrally controlled
SOEs. Additionally, a greater share of the economy (mainly the export sector) was exposed
to competitive forces. Local and provincial governments were allowed to establish and
operate various enterprises on market principles, without interference from the central
government. In addition, foreign direct investment (FDI) in China brought with it new
technology and processes that boosted efficiency.
Measuring the Size of China’s Economy
The actual size of the China’s economy has been a subject of extensive debate among
economists. Measured in U.S. dollars using nominal exchange rates, China’s GDP in 2005
is estimated at about $2.3 trillion; its per capita GDP (a commonly used living-standards
measurement) was $1,700. Such data would indicate that China’s economy and living
standards are significantly lower than those of the United States and Japan, respectively
considered to be the number-one and number-two largest economies (see Table 2).
Many economists, however, contend that using nominal exchange rates to convert
Chinese data into U.S. dollars substantially underestimates the size of China’s economy.
This is because prices in China for many goods and services are significantly lower than
those in the United States and other developed countries. Economists have attempted to
factor in these price differentials by using a purchasing power parity (PPP) measurement,
which attempts to convert foreign currencies into U.S. dollars on the basis of the actual
purchasing power of such currency (based on surveys of the prices of various goods and
services) in each respective country. This PPP exchange rate is then used to convert foreign
economic data in national currencies into U.S. dollars.
Because prices for many goods and services are significantly lower in China than in the
United States and other developed countries (while prices in Japan are higher), the PPP
exchange rate raises the estimated size of Chinese economy from $2.3 trillion (nominal
dollars) to $8.4 trillion (PPP dollars), significantly larger than Japan’s GDP in PPPs ($3.9
trillion), and about 67% the size of the U.S. economy. PPP data also raise China’s per capita
GDP to $6,386. The PPP figures indicate that, while the size of China’s economy is
substantial, its living standards fall far below those of the U.S. and Japan. China’s per capita
GDP on a PPP basis is only 15.2% of U.S. levels. Thus, even if China’s GDP were to
overtake that of the United States in the next few decades, its living standards would remain
substantially below those of the United States for many years to come.
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Table 2. Comparisons of United States, Japanese, and Chinese GDP
and Per Capita GDP in Nominal U.S. Dollars and PPP, 2005
Nominal GDP ($
GDP in PPP
Nominal Per
Per Capita
Country
billions)
($ billions)
Capita GDP
GDP in PPP
United States
12,458
12,458
42,130
42,130
Japan
4,571
3,914
35,880
30,720
China
2,262
8,359
1,700
6,386
Source: Economist Intelligence Unit Data Services and Global Insight.
Note: PPP data for China should be interpreted with caution. China is not a fully developed market economy;
the prices of many goods and services are distorted due to price controls and government subsidies.
Foreign Direct Investment in China
China’s trade and investment reforms and incentives led to a surge in foreign direct
investment (FDI), which has been a major source of China’s capital growth. Annual utilized
FDI in China grew from $636 million in 1983 to $60 billion in 2005 The cumulative level
of FDI in China stood at about $621 billion at the end of 2005. Analysts predict that FDI will
continue to pour into China as investment barriers are reduced under China’s WTO
commitments and Chinese demand for imports continues to increase.
Based on cumulative FDI for 1979-2005 about 42%of FDI in China has come from
Hong Kong. In 2005, Japan replaced the United States as second largest overall investor in
China. The United States ranked third accounting for 8.2% ($51.1 billion) of total FDI.
Other major investors include the British Virgin Islands, Taiwan, and South Korea (see
Table 3).3 U.S. FDI in China for 2005 was $3.1 billion (compared to $3.9 billion in 2004),
accounting for 5.1% of FDI for that year, and ranked 5th after Hong Kong, the British Virgin
Islands, Japan, and South Korea.4
3 According to the Chinese Ministry of Commerce, major U.S. investors in China (based on 2003
sales volumes) include Motorola ($5.8 billion in sales volume), General Motors ($2.2 billion), Dell
Computer ($2.1 billion), Hewlett Packard ($1.3 billion), and Kodak ($0.6 billion).
4 The British Virgin Islands is a large source of FDI because of its status as a tax haven. Much of
the FDI originating from Hong Kong comes from non-Hong Kong investors, such as Taiwanese.
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Table 3. Major Foreign Investors in China: 1979-2005
($ billions and % of total)
Cumulative Utilized FDI:
1979-2005
Utilized FDI in 2005
Amount
Amount
Country
($ billions)
% of Total
($ billions)
% of Total
Total
620.7
100.0
60.3
100.0
Hong Kong
259.5
41.8
17.9
29.7
Japan
53.3
8.6
6.5
10.8
United States
51.1
8.2
3.1
5.1
British Virgin Islands
45.9
7.4
9.0
14.9
Taiwan 41.8
6.7
2.2
3.3
South Korea
31.1
5.0
5.2
8.6
Source: Chinese government statistics. Top six investors according to cumulative FDI from 1979 to 2005.
China’s Trade Patterns
Economic reforms have transferred China into a major trading power. Chinese exports
rose from $14 billion in 1979 to $762 billion in 2005, while imports over this period grew
from $16 billion to $660 billion (see Table 4). In 2004, China surpassed Japan as the
world’s third-largest trading economy (after the United States and Germany). China’s trade
continues to grow dramatically: From 2002 to 2005, the size of China’s exports and imports
more than doubled. In 2005, exports and imports rose by 28.4% and 17.6%, respectively.
China’s trade surplus, which totaled $32 billion in 2004, tripled to $102 billion.
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Table 4. China’s Merchandise World Trade, 1979-2005
($ billions)
Trade
Year
Exports
Imports
balance
1979
13.7
15.7
-2.0
1980
18.1
19.5
-1.4
1981
21.5
21.6
-0.1
1982
21.9
18.9
2.9
1983
22.1
21.3
0.8
1984
24.8
26.0
-1.1
1985
27.3
42.5
-15.3
1986
31.4
43.2
-11.9
1987
39.4
43.2
-3.8
1988
47.6
55.3
-7.7
1989
52.9
59.1
-6.2
1990
62.9
53.9
9.0
1991
71.9
63.9
8.1
1992
85.5
81.8
3.6
1993
91.6
103.6
-11.9
1994
120.8
115.6
5.2
1995
148.8
132.1
16.7
1996
151.1
138.8
12.3
1997 182.7
142.2
40.5
1998
183.8
140.2
43.6
1999 194.9
165.8
29.1
2000 249.2
225.1
24.1
2001 266.2
243.6
22.6
2002 325.6
295.2
30.4
2003 438.4
412.8
25.6
2004
593.4
561.4
32.0
2005
762.0
660.1
101.9
Source: International Monetary Fund, Direction of Trade Statistics, and official Chinese statistics.
Data for the first three months of 2006 indicate that China’s rapid trade growth is
continuing, although at a slightly slower pace than 2005 levels. During this period, exports
and imports rose by 26.6% and 24.8%, respectively over the same period in 2005.

Merchandise trade surpluses, large-scale foreign investment, and its peg to the U.S.
dollar have enabled China to accumulate the world’s second largest foreign exchange (after
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Japan). As seen in Figure 1, China’s accumulation of foreign exchange reserves has been
particularly acute over the past few years. China’s total reserves reached $875.1 billion at the
end of March 2006, more than double the level China had at the end of 2003. As of February
2006, China has become the world’s largest holder of foreign exchange reserves. Many
analysts contend China’s reserves could hit $1 trillion by the end of 2006.
Figure 1. China’s Foreign Exchange Reserves: 1990-March 2006
($ in billions)
$1000
$875.1
$818.9
$800
$609.9
$600
$408.2
$400
$291.1
$215.6
$200
$149.2 $157.7 $168.3
$132.8
$107
$76.4
29.6
34.7
$20.6 $22.4 $32.9
0
1991
1993
1995
1997
1999
2001
2003
2005
1990
1992
1994
1996
1998
2000
2002
2004
March 2006
Source: Official Chinese government data.
China’s Major Trading Partners
China’s trade data often differ significantly from those of its major trading partners.
This is due to the fact that a large share of China’s trade (both exports and imports) passes
through Hong Kong (which reverted back to Chinese rule in July 1997 but is treated as a
separate customs area by most countries, including China and the United States). China
treats a large share of its exports through Hong Kong as Chinese exports to Hong Kong for
statistical purposes, while many countries that import Chinese products through Hong Kong
generally attribute their origin to China for statistical purposes. According to Chinese trade
data, its top five trading partners in 2004 were the European Union (EU), the United States,
Japan, Hong Kong, and the 10 nations that constitute the Association of Southeast Asian
Nations (ASEAN) (see Table 5). China’s largest export markets were the United States,
Hong Kong, and the EU, while its top sources for imports were Japan, the EU, and Taiwan
(the United States ranked sixth).
U.S. trade data indicate that the importance of the U.S. market to China’s export sector
is likely much higher than is reflected in Chinese trade data. Based on U.S. data on Chinese
exports to the United States (which, as noted, do not agree with Chinese data), and Chinese
data on total Chinese exports, it is estimated that Chinese exports to the United States as a
share of total Chinese exports grew from 15.3% in 1986 to 32.0% in 2005.
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A growing level of Chinese exports is from foreign-funded enterprises (FFEs) in China.
According to Chinese data, FFEs were responsible for 58% of Chinese exports in 2005,
compared with 41% in 1996. A large share of these FFEs are owned by Hong Kong and
Taiwan investors, many of whom have shifted their labor-intensive, export-oriented, firms
to China to take advantage of low-cost labor. A significant share of the products made by
such firms is likely exported to the United States.
Table 5. China’s Top Five Trading Partners: 2005
($ billions)
Trade
Balance as
Total
Chinese
Chinese
China’s trade
Reported by
Country
trade
exports
imports
balance
Partner
Hong Kong
246.8
124.5
122.3
2.2
-4.7
European Union
219.3
143.7
75.6
68.1
-132
United States
211.6
162.9
48.7
114.2
-201.6
Japan 184.5
84.0
100.5
-16.5
-28.5
ASEAN*
130.4
55.4
75.0
-19.6
N/A
Sources: Official Chinese trade data and Global Trade Atlas.
Note: Chinese data on its bilateral trade often differ substantially from the official trade data of other countries
on their trade with China.
* Association of Southeast Asian Nations (ASEAN) member countries are Indonesia, Malaysia, the Philippines,
Singapore, Thailand, Brunei, Cambodia, Laos, Myanmar (Burma), and Vietnam.
Major Chinese Trade Commodities
China’s abundance of cheap labor has made it internationally competitive in many low-
cost, labor-intensive manufactures. As a result, manufactured products constitute an
increasingly larger share of China’s trade. A large share of China’s imports, such as raw
materials, components and parts, and production machinery is used to manufacture products
for export. For example, China imports cotton and textile-production machinery (and
cotton) to produce textile and apparel items. A substantial amount of China’s imports is
comprised of parts and components that are assembled in Chinese factories (major products
include consumer electronic products and computers), then exported. China’s top five
exports in 2005 were (1) automatic data processing machines and units, (2) garments and
clothing accessories, (3) textile products, (4) parts of data processing machines, and (5) radio
telephone handsets (see Table 6). China’s top imports were (1) electronic integrated circuits
and micro-assemblies, (2) crude oil, (3) liquid crystal display panels, (4) steel products, and
(5) plastics (see Table 7).5
5 Rankings differ according to which trade classification is used and at what digit level.
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Table 6. Major Chinese Exports, 2005
($ billions and % change over previous year)
Amount
Percent Increase over 2004
Automatic data processing machines and units
74.5
28.6
Garments and clothing accessories
73.4
20.0
Textile products
40.9
23.9
Parts of data processing machines
27.7
20.4
Radio telephone handsets
19.7
44.8
Source: China’s Customs Statistics. Estimated, based on January-November 2005 data.
Table 7. Major Chinese Imports, 2005
($ billions and % change over previous year)
Amount
Percent Change over 2004
Electronic integrated circuits
79.3
32.0
and micro-assemblies
Crude oil
47.2
43.5
Liquid crystal display panels
26.8
27.5
Steel products
25.0
20.7
Plastics
24.1
18.6
Source: China’s Customs Statistics. Estimated, based on January-November 2005 data.
Major Long-Term Challenges Facing
the Chinese Economy
China’s economy has shown remarkable economic growth over the past several years,
and many economists project that it will enjoy fairly healthy growth in the near future.
However, economists caution that these projections are likely to occur only if China
continues to make major reforms to its economy. Failure to implement such reforms could
endanger future growth.
! State-owned enterprises (SOEs), which account for about one-third of
Chinese industrial production, put a heavy strain on China’s economy. Over
half are believed to lose money and must be supported by subsidies, mainly
through state banks. Government support of unprofitable SOEs diverts
resources away from potentially more efficient and profitable enterprises.
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In addition, the poor financial condition of many SOEs makes it difficult for
the government to reduce trade barriers out of fear that doing so would lead
to widespread bankruptcies among many SOEs.
! The banking system faces several major difficulties due to its financial
support of SOEs and its failure to operate solely on market-based principles.
China’s banking system is regulated and controlled by the central
government, which sets interest rates and attempts to allocate credit to
certain Chinese firms. The central government has used the banking system
to keep afloat money-losing SOEs by pressuring state banks to provide low-
interest loans, without which a large number of the SOEs would likely go
bankrupt. Currently, over 50% of state-owned bank loans now go to the
SOEs, even though a large share of loans are not likely to be repaid. The
precarious financial state of the Chinese banking system has made Chinese
reformers reluctant to open the banking sector to foreign competition.
Corruption poses another problem for China’s banking system because loans
are often made on the basis of political connections. This system promotes
widespread inefficiency in the economy because savings are generally not
allocated on the basis of obtaining the highest possible returns.
! Public unrest over pollution, government corruption, and growing
income inequality poses threats to social stability. The Chinese
government reported that there were over 74,000 protests (many of which
became violent) involving 3.8 million people in 2004 (up from 53,000
protests in 2003) over such issues as pollution, government corruption, and
land seizures. Pollution in China continues to worsen, posing series health
risks to the population. The Chinese government often disregards its own
environmental laws in order to promote rapid economic growth. According
to the World Bank, 16 out of 20 of the world’s most polluted cities are in
China, and the direct costs to the economy (such as health problems, crop
failures and water shortages) is estimated to be hundreds of billions of
dollars yearly. The Chinese government estimates that there are over 300
million people living in rural areas that drink unsafe water (caused by
chemicals and other contaminants). Toxic spills in China in recent months
have threatened the water supply of millions of people. Rising income
inequality, particularly between people living in the urban coastal and those
living in the inner rural regions of China, has become another source of
tension. A number of protests in China have stemmed in part from
frustrations among many Chinese (especially peasants) that they are not
benefitting from China’s economic reforms and rapid growth, and
perceptions that those who are getting rich are doing so because they have
connections with government officials. Protests have broken out over
government land seizures and plant shutdowns in large part due to
perceptions that these actions benefitted a select group with connections. A
2005 United Nations report stated that the income gap between the urban
and rural areas was among the highest in the world and warned that this gap
threatens social stability. The report urged China to take greater steps to
improve conditions for the rural poor, and bolster education, health care, and
the social security system.
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! The lack of the rule of law in China has led to widespread government
corruption, financial speculation, and misallocation of investment funds. In
many cases, government “connections,” not market forces, are the main
determinant of successful firms in China. Many U.S. firms find it difficult
to do business in China because rules and regulations are generally not
consistent or transparent, contracts are not easily enforced, and intellectual
property rights are not protected (due to the lack of an independent judicial
system). The lack of the rule of law in China limits competition and
undermines the efficient allocation of goods and services in the economy.
Outlook for China’s Economy and Implications
for the United States
The short-term outlook for the Chinese economy appears to be positive, but it will likely
be strongly influenced by the government’s ability to reform the SOEs and banking system
to make them more responsive to market forces, increase the flexibility of its exchange rate
policy, and to assist workers who lose their jobs due to economic reforms (in order to
maintain social stability). Global Insight, an economic forecasting firm, projects that China’s
real GDP will average 7.8% over the next 10 years, indicating that China could double the
size of its economy in less than 10 years.6 The Economist Intelligence Unit projects that
China will become the world’s largest exporter by 2010 and the world’s largest economy by
2020.
China’s rise as an economic superpower is likely to pose both opportunities and
challenges for the United States and the world trading system. China’s rapid economic
growth has boosted incomes and is making China a huge market for a variety of goods and
services. In addition, China’s abundant low-cost labor has led multinational corporations to
shift their export-oriented, labor-intensive manufacturing facilities to China. This process
has lowered prices for consumers, boosting their purchasing power. It has also lowered costs
for firms that import and use Chinese-made components and parts to produce manufactured
goods, boosting their competitiveness. Conversely, China’s role as a major international
manufacturer has raised a number of concerns. Many developing countries worry that
growing FDI in China is coming at the expense of FDI in their country. Policymakers in both
developing and developed countries have expressed concern over the loss of domestic
manufacturing jobs that have shifted to China (as well as the downward pressures on
domestic wages and prices that may occur from competing against low-cost Chinese-made
goods).
Many analysts contend that China’s currency policy, despite reforms undertaken in July
2005, is having a negative impact on the economies of many of its trading partners by
artificially making its exports cheaper, and imports more expensive, than they would be
under a floating system. They have urged China to move toward a floating exchange rate
regime as soon as possible, contending that such a move would benefit China’s economy and
6 Global Insight, China: Interim Forecast Analysis: Economic Growth, December 15, 2005.
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those of its trading partners.7 For example, China’s accumulation of large foreign exchange
reserves has forced it to increase the money supply, which may eventually lead to inflationary
pressures on the economy. In addition, many analysts contend that easy money policies have
led to over-investment in certain economic sectors. However, Chinese officials have
expressed concern that further currency reforms, if implemented too quickly, could prove
disruptive to the economy. A number of bills have been introduced in Congress to address
Chinese currency policy, including some that would impose a 27.5% tariff on Chinese goods
unless China appreciated its currency to market levels.8 Failure by China to implement
further reforms to its currency regime could prompt Congress to take up currency-related
legislation. On the other hand, some analysts have raised concerns that currency reforms may
induce China to diminish its purchases of U.S. Treasury securities, which could affect U.S.
interest rates.
China is attempting to establish and promote companies that can compete globally,
especially in advanced technologies. In some cases, China has attempted to purchase large
foreign companies. For example, in December 2004, Lenovo Group Limited, a computer
company primarily owned by the Chinese government, purchased IBM’s personal computer
division. In June 2005, the China National Offshore Oil Corporation (CNOOC) made a bid
to buy a U.S. energy company, UNOCAL, for $18.5 billion, although strong opposition in
Congress forced CNOOC to withdraw its bid. China’s possession of large currency reserves
and desire to become a world leader in the production of a variety of goods and strategic
commodities will likely lead the Chinese government to expand efforts to take over major
international corporations. Many Members charge that China’s use of extensive subsidies
to support state-owned firms, especially to fund takeover bids, threatens U.S. economic
interests and may violate its WTO commitments.

China’s rapid economic growth and continued expansion of its manufacturing base are
fueling a sharp demand for energy and raw materials, which is becoming an increasingly
important factor in determining world prices for such commodities. China is now the
world’s second largest consumer of oil products (after the United States) at 6.7 million
barrels per day, and that level is projected to double to 13.4 million barrels per day by 2025.9
According to the U.S. Energy Information Administration, around 40% of world oil demand
growth over the past four years came from China and this demand is “a very significant
factor in world oil markets.”10 China has also reportedly become the largest consumer of
steel, cement, and copper.
Some U.S. policymakers have expressed concern over China’s rising ownership of U.S.
government debt, due to fears that China might attempt to use its holdings as leverage in its
dealings with the United States on economic and/or political matters. China is the second
largest foreign holder of Treasury securities (after Japan), and both the level of those
7 For a discussion of this issue, see CRS Report RS21625: China’s Currency Peg: A Summary of
the Economic Issues, by Wayne Morrison and Marc Labonte.
8 For a listing of these bills, See CRS Issue Brief IB91121,China-U.S. Trade Issues, by Wayne M.
Morrison.
9 Global Insight, Global Petroleum Outlook Forecast Tables (Long-Term), January 2005.
10 U.S. Energy Information Administration website at [http://www.eia.doe.gov/].
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holdings and China’s share of total foreign holdings have increased sharply over the past few
years. These went from $51.8 billion in 1999 to $265.2 billion at end of February 2006.
China’s U.S. Treasury securities holdings as a share of total foreign holdings over this period
have grown from 4.1% to 11.9%. Some have raised concerns that threats by China to halt
future purchases, or to sell existing holdings, could cause the value of the dollar to depreciate
in world markets (raising import prices), increase U.S. interest rates, lead to a decline in U.S.
stock and bond markets, and possibly cause the U.S. economy to slow. However, any such
disruption to the U.S. economy would also hurt China’s economy since about a third of
China’s exports go to the United States.
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