Select Committee on Foreign Affairs Seventh Report

2  ECONOMICS

5. Since Deng Xiaoping introduced his Open Door policy in 1978, the rapid growth of its economy has transformed the People's Republic of China (PRC). Between 1991 and 2001, the Chinese economy grew at an average of about 9.9% per annum. Exports have increased from $22 billion in the early 1980s to $249 billion in 2000 and $593 billion in 2004, representing about 35% of Chinese gross domestic product (GDP). Foreign direct investment (FDI), much from the Hong Kong and overseas Chinese communities, including Taiwan, has remained steady at about $50-60 billion per annum, and consumer spending has grown from about $155 billion in the early 1980s to $650 billion in 2003.[9] China's 1.3 billion people have a GDP per capita of about $5,400, adjusted for purchasing power parity (ppp).[10] The graph below shows China's rate of growth since 1997, compared with the EU and US.

6. Commenting on the growth of the Chinese economy, the Foreign and Commonwealth Office (FCO) memorandum to our inquiry stated that:

The Chinese economy grew by 9.5% in 2004 and annual growth of 9% is forecast this year […] China's long term goal is to quadruple GDP between 2000 and 2020 […] Its share of world trade—now at 8%—has doubled in the last decade and it is forecast to become the world's largest exporter by 2010 and possibly overtake Japan as the second largest economy in the world within a decade.[11]

7. China's spectacular economic growth has resulted in vast quantities of manufactured goods flooding onto the global market, Chinese companies searching overseas for commodity sources with which to fuel the boom and a growing assertiveness in Chinese foreign policy, all of which are changing the international system. We saw at first hand the scale of the transformations affecting China.

8. Maintaining this growth rate is of the greatest importance for the Chinese Communist Party (CCP) because increasing wealth and living standards for the population is one of the CCP's chief sources of legitimacy. Dr Christopher Hughes, Director, Asia Research Centre, London School of Economics and Political Science, told us that economic growth had become one of the "three pillars of legitimacy for the leadership".[12] Yet the precipitate rates of growth present serious challenges for the Chinese authorities. Professor Yongnian Zheng, Head of Research of the China Policy Institute at the University of Nottingham, told us: "The problem now for the Chinese government is how to manage the economic growth."[13]

Foreign Direct Investment and Trade

9. China's growth has been driven by exports, and by 2010 the OECD estimates that China will be the world's leading exporter.[14] Dr Yueh, of Pembroke College, University of Oxford, explained in her memorandum:

Over the period 1990-2000, Chinese manufactured exports grew by 16.9% per annum, compared with 10.3% for the rest of East Asia, and its world market share tripled during that period […] By 2005, China accounted for around 6% of global markets in manufactured goods. [15]

10. The World Trade Organisation's statistics for trade in 2004 show China's place in the global league table of manufacturing exporters and importers:[16]

China's membership of the World Trade Organisation (WTO) has helped growth in trade. China joined the WTO in 2001, signing an agreement which permitted a five year transition period before the liberalisation of its economy in line with WTO standards. Entry to the WTO gave reform-minded officials the power to enact unpopular reforms. Dr Christopher Hughes told us: "The WTO was used very much within domestic politics to do things that could not have been done anyway."[17] Professor David Wall, of the Centre of Chinese Studies at the School of Oriental and African Studies, University of London, and Chatham House, told us that opinion in China favoured liberalisation, saying: "If you sit down with people from Beijing, they would say, 'Yes, we are all in favour of all these liberalisation processes'. They can see the link between the liberalisation and economic growth and the strength of China."[18]

11. 2006 is the final year of China's five year transition period to full WTO membership. However, much work still needs to be done before the Chinese economy operates on a basis similar to that of the United Kingdom or the USA. Dr Yueh wrote: "China's legal and regulatory systems are adopting reforms quickly, but the laws and structures in place are not yet matched by enforcement."[19]

12. Professor Wall pointed in particular to problems with the legal system and told us that people could either work within the guanxi, or 'connections', system, or try to use the legal system, although enforcement of court decisions is extremely difficult even in the event of a court victory.[20] However, Lord Powell of Bayswater KCMG, President of the China Britain Business Council, took a more optimistic line. He told us: "I think there has been some progress towards developing a rule of law in China. It is very, very far from complete but a real effort is now being made to make the courts more efficient and more just, to make redress through legal channels possible."[21]

13. Legal issues are a high concern for investors, given the role played by foreign direct investment in China's growth. Most of its exports have been driven by overseas companies setting up in China; in the first 11 months of 2005, 58% of China's exports were produced by foreign companies.[22] Dr Yueh outlined the role played by FDI in China's export economy:

The way that China has increased exports is via attracting foreign direct investment, taking those multinationals which are investing in China and putting them into joint ventures with Chinese firms […] One [element] is, if a Chinese firm is in partnership with a foreign firm with more advanced technology, it facilitates the technological upgrading of that Chinese firm, which would allow China to grow even if the export side were to slow. The other element is, by attracting foreign direct investment in this way, China has plugged itself into what we call 'production chains' across Asia.[23]

14. However, Dr Steve Tsang, Fellow of St Antony's College, Oxford, was less optimistic about the future role of FDI, and stated in his memorandum that:

There is a serious question whether China can sustain such a high rate of growth uninterrupted for another two to three decades. Indeed, with so much of China's growth being driven by foreign investments, it faces a grave danger that its growth momentum may collapse if, for example, a critical mass of the largest foreign investors no longer accepts that it is worthwhile to take substantial losses for many years before turning a profit.[24]

15. At present, China's exports continue to grow overall. However, they have tended to be low value-added products offering only slim profit margins. However, China's companies are now improving their technology and aiming to increase the quality of their exports as did Japan and Taiwan during their periods of economic 'take-off'. Professor Catherine Schenk, of the Department of Economic and Social History at Glasgow University, stated in evidence that:

Chinese exports will continue to diversify away from labour-intensive products. In January 2006 Geely International exhibited the first Chinese-made car at the Detroit auto-show. Another Chinese car manufacturer, Chery, plans to begin exports to the USA at the end of 2007.[25]

16. Dr Yueh also described China's investments in producing high technology goods, which "has in the past few years led China to become the world's second-largest investor in R&D, in per capita terms":

The education of scientific personnel and the development of infrastructure have accordingly been a priority. Coupled with access to foreign capital and global markets, China is attempting to increase the technological component of its growth model to sustain a rate of growth that would otherwise begin to slow.[26]

17. If these trends persist it is likely that China will give great emphasis to technology transfer from foreign companies, and the quality and technological content of, and the value added to, China's exports may well improve over the coming years, presenting manufacturers across the industrialised world with a major challenge.

18. The Foreign Secretary, Rt Hon Margaret Beckett MP, was positive about China's role in the global economy. She told us: "My Department, as with the rest of the British Government, is very much a department that recognises the benefits and the advantages of free trade. With all of the shorter-term difficulties that that can sometimes create, we still believe that it is in the long term beneficial."[27]

19. We conclude that the growth of China's trade will continue to have an enormous impact on the world economy, both by providing consumers with cheap goods and by presenting manufacturers with a serious challenge, although China's dependence on foreign direct investment could increase the potential for economic shocks. We further conclude that Chinese companies will strive to increase the technological content of their products and so the challenge for companies competing in this sector will be very likely to intensify. However, foreign investors and traders can profit greatly from these transformations, provided China adheres to its World Trade Organisation commitments. We recommend that the Government work both bilaterally and with its EU partners to engage its counterparts in Beijing to ensure that China works within the spirit, and not just the letter, of its World Trade Organisation obligations.

FRICTIONS

20. China's growing trading power is creating frictions with the USA and EU. Professor Schenk explained: "China's competitiveness in export of labour-intensive production has already generated considerable trade friction with the USA and the EU. In 2005 the USA trade deficit with China grew 45% and the USA launched 11 anti-dumping investigations against China".[28]

21. One dimension of these trading disagreements is visible in one of China's current goals in its relations with the EU—the attainment of 'market economy' status. In 1998 China was reclassified as a transition economy by the EU, and in 2001 China agreed that the definition would stand until 2015. This means that although China will become a full member of the WTO this year, the EU and other trading partners can more easily enact anti-dumping measures against Chinese firms. Dr Christopher Dent from the Department of East Asian Studies, University of Leeds, wrote in his submission: "The EU still applies a number of anti-dumping duties in Chinese imports, for example on bicycles, and has expressed its concern over China's managed exchange rate, although not as vehemently as the United States has done."[29] The matter is a totem of national pride in China; Beijing sees definition as a transition economy as discriminatory and the product of EU protectionism.[30]

22. Trade frictions with the EU came to a head in a dispute over textiles in 2005. The European Commissioner for External Trade, Peter Mandelson, negotiated a settlement in September 2005, which permitted the entry of excess textiles to be counted against the quotas for 2006. [31] Professor Wall was critical of this deal. He told us: "It is only playing around at the margin. In the long run, the world will have to adjust to the growth of Chinese textiles."[32] Other trade frictions between China and the EU are now arising, such as disputes over shoes and car parts, and China is taking an increasingly active role in international trade negotiations. The shoes issue has become a particular concern following the decision of Trade Commissioner Mandelson to institute a levy on children's shoes manufactured in China in July 2006, which might raise the cost to consumers and limit China's trade with the EU.[33]

23. We asked the Foreign Secretary about EU trade policy. She told us:

there is a responsibility on us, particularly as we do […] believe in the advantages of free trade, to try to show China on issues like the textile issue and shoe issue, and so on, that the multi-lateral trade regime works, and it works fairly […] Of course, there will always be different national interests and different nuances of approach, but I think that there is a recognition within the EU of the advantages of a proper multi-lateral regime and of free trade. Insofar as there are growing protectionist concerns in the EU, that is a global phenomenon.[34]

24. We conclude that the world must take account of the economic changes occurring in China and cannot simply close the door on Chinese goods; any attempts at protectionism would damage attempts to bind Beijing effectively into the existing international order. We further conclude that the preservation of the global multi-lateral trading structures has become more important than ever with the emergence of the Chinese economy. We recommend that the United Kingdom maintain its championship of free trade between the European Union and China, by working with other advocates of free trade within the EU to support trade with China. We conclude that China must not resort to unfair trade practices such as dumping and must work within the existing rules in order to strengthen support for free and fair trade within the EU.

25. The United States also has serious trade frictions with Beijing. China runs consistent large trade surpluses with the USA, and its imports have had a major impact on the politically sensitive US manufacturing sector. Underlining protectionist frictions, in September 2005 the then US Deputy Secretary of State Robert Zoellick said:

The US business community, which in the 1990s saw China as a land of opportunity, now has a more mixed assessment. Smaller companies worry about Chinese competition, rampant piracy, counterfeiting, and currency manipulation. Even larger companies, once the backbone of support for economic engagement—are concerned that mercantilist Chinese policies will try to direct controlled markets instead of opening competitive markets.[35]

In February 2006 China accounted for about 23% of the total US trade deficit of $782 billion.[36] In response to growing concerns, the US Government launched a task force on 15 February 2006 to scrutinise trade between the USA and China.[37]

26. Part of the difficulty stems from US perceptions that the Chinese currency, the renminbi, or yuan, is undervalued, so providing a trading advantage to Chinese goods in the US market. According to the US Congress, China's currency reserves, which total about $875.1 billion, are one sign of this undervaluation.[38] However, the US Treasury contends that the trade surplus is not a sign of undervaluation, since while China runs a trade surplus with the USA, it has a deficit with states in Asia. Much of China's trade consists of re-export of goods from Japan or other Asian manufacturers, and China's overall global surplus, which is a better indication of the valuation of the renminbi, is reasonably small—some 3%.[39]

27. Notwithstanding the economic arguments, the cause of urging China to revalue the renminbi has won political support from a broad spectrum within the US Congress. In response, China agreed to shift its currency regime in July 2005 from a straight peg to the US dollar to a basket of currencies including the Korean won, the Japanese yen, the US dollar and the European euro, and revalued the renminbi by 2.1%; the currency since strengthened further in May 2006. These moves have staved off some protectionist sentiment in the USA, but feelings remain strong.

28. We asked Dr Cronin, Director of Studies at the International Institute for Strategic Studies, about revaluing the renminbi. He told us: "It is not an elixir that solves the problem […] but there is this concern about competitiveness. The fact is that it does need to reflect that new value and it has not."[40] Dr Swenson-Wright of the East Asia Institute, University of Cambridge, added: "The Chinese official line is that, given the weakness of their internal banking sector, they worry particularly about the exposure to speculation if they were to allow their currency to float."[41]

29. Another source of contention on trade matters between Beijing and Washington and the EU is the continued infringement of intellectual property rights (IPR) in China. Robert Zoellick, former US Deputy Secretary of State, said in September 2005:

A responsible major global player shouldn't tolerate rampant theft of intellectual property and counterfeiting, both of which strike at the heart of America's knowledge economy. China's pledges […] to crack down on the criminals who ply this trade are welcome, but the results are not yet evident."[42]

The EU has strong concerns about intellectual property rights too; the statement issued at the end of the EU-China summit in September 2005 stated:

[Both sides] recognised the vital importance of transparency in commercial decision making, robust corporate governance, effective implementation of protection of intellectual property and safeguarding the interest of consumers in creating a positive business environment for continued economic growth and individual prosperity. With this in mind China and the EU agreed to deepen the dialogue on intellectual property rights.[43]

30. We asked Professor Wall about intellectual property. He told us: "Central government, which you deal with, is very rational […] and well trained […but] they cannot stop the people in the streets selling CDs and DVDs […] The people who are doing it have political connections and you cannot clamp down, they have political support."[44]

31. Sebastian Wood CMG, Director, Asia-Pacific at the Foreign and Commonwealth Office, agreed that implementation was the problem. He said: "The problem that we identify the Chinese have is really a problem of law enforcement and implementation. They have the political will, they have set the right legal and regulatory frameworks, or are trying to do so."[45] Denis Keefe, Head of the FCO's Far Eastern Group, also pointed to the domestic imperative for improvements. He told us: "The progress the Chinese have made in their own internal systems for dealing with intellectual property issues are increasingly being exploited by Chinese companies themselves who can see that their own interests are damaged."[46] Yet until a solid basis for intellectual property rights exists in China, international companies may hesitate before installing their latest technology and domestic innovation may suffer from the lack of security available to creative individuals.

32. We conclude that the Government must urge its counterparts in Washington and in the EU not to succumb to the temptations of protectionism, even in the face of growing trade frictions such as those over the value of the Chinese currency. We further conclude that the protection of intellectual property rights is essential for the effective functioning of a creative, innovative economy. Unless the Chinese government takes greater steps to establish secure intellectual property rights, tensions between China and its trading partners will grow and domestic innovation will suffer. We recommend that the Government work with the Chinese government to establish a legal framework in which intellectual property rights can be enforced, and we recommend that it set out in its response to this Report how it is doing so.

Domestic Reform

Income Inequality

33. China's growth has increased prosperity but has not spread wealth equitably. Growing economic disparities within China point to severe fault lines in the current system of growth which have the potential to evolve into increasing instability and opposition to CCP rule. Professor Jude Howell, Director of the Centre for Civil Society at the London School of Economics and Political Science, told us:

the economic reforms, the pace of change and the rapid growth are putting enormous pressures on society and governance. One of the issues that the new leadership and previous leaders have been concerned about is the growing inequality: across generations, between rural and urban areas, and across different sectors of society.[47]

34. Professor Schenk also stated in evidence that:

China's economic growth has been accompanied by worsening inequalities in the geographic distribution of income. This has generated a flow of migrants from rural and poorer provinces to the main cities, not all of whom have been able to find employment. In 2005 the government's statistics showed that the poorest 10% of families own less than 2% of residents' assets, while the top 10% of families own over 40% of total assets.[48]

35. The FCO outlined the Chinese government's plans to establish more balanced economic growth:

In October 2005 the Party Plenum meeting chaired by President Hu approved the 11th Five-Year Plan (2006-2010). This guiding document sets out the Government's broad policy aims of maintaining China's stable rate of economic growth while speeding up structural adjustments to the economy. The plan also emphasises the Government's commitments to protecting the environment, encouraging innovation, achieving social justice, harmonizing inequalities in the pace of regional development and achieving a better balance between industry and agriculture.[49]

36. However, the inefficiency of some parts of the state-owned sector limits the economy's growth and efforts to rebalance income distribution, because of the complexity of the necessary reforms. Dr Yueh told us: "These [state-owned enterprises or SOEs] have the potential to be inefficient, and large numbers of them are."[50] She described the social consequences of reform of the SOEs:

The state-owned enterprises […] are not just enterprises, but providers of social security and instruments for the government policy of maintaining full employment. Despite the inefficiency of state-owned enterprises, they did not shed labour until the large-scale layoffs of the mid-1990s. China's urban unemployment rate until then did not exceed 3.5%. Urban unemployment, more broadly defined to include laid-off workers and other forms of non-employment, is now estimated to be as high as 8-12%. Since there is no social safety net and on account of concerns about instability, the restructuring of the state-owned enterprises and banks will be a difficult challenge for China.[51]

37. Nonetheless, the government has slowly reformed the SOEs by fully privatising small ones and carrying out share issue privatisation for bigger ones in an effort to introduce better standards of corporate governance, which has increased their efficiency levels, although the question of privatising their parent companies is as yet unanswered.[52]

38. Another concern is that China's economy may be overheating. Professor Schenk stated in her evidence that:

In 2003 the IMF identified potential over-heating of the economy and recommended policies to reduce the growth rate of capital accumulation to prevent bottlenecks [...] These appeared to have been somewhat successful in the first half of 2005 but there was a further acceleration in the second half of the year.[53]

39. Revaluation of the renminbi might slow down growth and reduce the likelihood of inflation and may also help to stimulate the domestic market. However, any revaluation could have a serious impact on China's export sector, which might contribute to higher levels of unemployment. At present, concerns about overinvestment remain salient.

40. Overall, China's appetite for economic reform provides great opportunities for foreign governments and businesses to provide advice and influence the evolution of Chinese economic policy. The FCO memorandum suggests that the UK should have a role in assisting China in promoting economic reform:

There is an unparalleled opportunity to promote a positive Chinese mindset on economic and structural reforms […] The UK and other Governments stand to contribute by providing specific expertise and in fostering technology transfer and professional know-how.[54]

41. We conclude that China's growing income inequality is a matter of concern. We commend the Chinese government's initiatives to close the income gap. We further conclude that China's appetite for economic reform provides a great opportunity for the United Kingdom to work with Chinese policymakers. We recommend that the Government set out in its response to this Report how the United Kingdom is engaging its Chinese counterparts on economic and social reforms and that it identify in which areas of British expertise, such as welfare provision, might best help the Chinese government to straddle the divide.

THE BANKING SYSTEM

42. Full reform of the SOEs will also require a root and branch transformation of the banking system. Professor Schenk told us that bad debt is rife within the Chinese banking system, much owed to the SOEs.[55] Dr Yueh assessed the problem of reform of the banking system, pointing to the economic and legal sides of reform. She told us:

On the economic side, for the banking sector official statistics say that the amount of non-performing loans are falling, but the underlying problem of non-performing loans is structural to the economy. State-owned banks have non-performing loans through policy-directed lending to state-owned enterprises […] Unless they are able to undertake a reform that creates jobs, creates a social safety net, improves the competitiveness of SOEs, and cuts off the flow of non-performing loans from the close relationship of the state-owned banks to the state-owned enterprises and the state, then even if the stock is falling the flow is likely to continue. That is the economic side.[56]

Dr Yueh continued:

On the legal side, China has always encouraged a dual-track reform process. It allows a market sector to develop alongside a non-market. So one of the ways in which China would like to improve the banking and the financial sector is to allow essentially private banks—non-state institutions—to increase their share in the entire lending system. This makes the state-owned banks' not-very-attractive portfolio shrink in relative size; but the difficulty of this approach […] is that you need to have legal, regulatory information, credit assessment, risk, and all of these types of structures in place before you could have a well-functioning private financial banking sector, driven by interest rates and driven by risk and profitability. [57]

43. In this context, the United Kingdom and its successful financial services sector have much to offer the Chinese government, both in expertise in transition issues, much gained in Russia and Eastern Europe, and also in investment from companies with experience of operating to global standards.

44. We conclude that until the banking system undergoes successful reforms, its weakness could undermine China's economic progress. We further conclude that the United Kingdom has much to offer, in terms of expertise in corporate governance and transition issues. We recommend that the Government set out in its response to this Report how it is helping the Chinese authorities to tackle the problem of reforming China's banking system.

Limits to Growth

Energy and Resources

45. China may also face a slowdown unless it can continue to secure the raw materials it needs to supply its manufacturing base. Professor Schenk said in evidence that "the growing shortage of key resources threatens to create a bottle-neck in China's industrial development."[58]

46. Commenting on this issue, the FCO wrote:

China's relatively low endowment of natural resources means that its material needs are substantial, and this is exerting a powerful influence on world commodity prices. As resource constraints are already constraining growth, the Chinese government has been looking increasingly actively for energy security. China currently accounts for 10% of global energy consumption, second only to the US. But this is likely to rise to 14% over the next decade […] China is already the world's largest coal burner; by 2020 it will consume over 40% of the world's total production. Most of its additional needs will be met by importing oil from the Middle East and Africa and gas from Russia.[59]

47. At present, China's overall energy use comprises 63.4% coal, 25.8% oil, 6.9% hydroelectricity, and 3.1% natural gas. China's efforts to reduce reliance on coal include the development of natural gas and the use of coal bed methane, adding hydropower capacity and developing wind and solar energy.[60] However, China's per capita energy use is much lower than that of the USA, despite its huge population. US energy consumption per capita is 11 times higher than China's consumption, and five times higher than the global average.[61]

48. Mr John Ashton, former Chief Executive of Third Generation Environmentalism, (E3G) explained why this was important for the United Kingdom. He told us:

We need a soft power China. That means a China which is successful and stable but, above all, a China that is achieving a transition to a much more efficient use of energy and other resources, and thereby accelerating the same transition for everybody else. China's current pattern of development is undermining its own stability.[62]

49. In this context, support for more efficient use of energy is essential. The United Kingdom and other states with advanced renewable energy industries and energy efficiency technologies could export their knowledge to a burgeoning Chinese market. At present, renewable sources, including hydroelectricity, account for about 18% of China's electricity production, and the government has put effort into expanding their role in the energy economy.[63] In meetings in Beijing we also heard that China was looking at various energy technologies to reduce its dependence on imports, particularly of oil, such as the production of ethanol to fuel cars and of liquid coal capabilities which would release far lower levels of carbon dioxide into the atmosphere.

50. John Ashton explained how China and the EU could co-operate on renewable energy development, stressing that any effective co-operation had to take place on a pan-European level simply because of the scale of the task. He said:

If you created, in effect, a single market between Europe and China for ultra-efficient appliances, for very efficient vehicles, for renewable energy products of one kind or another, then you would be accelerating the deployment of those technologies in China, in Europe; and you would be driving down the global prices of them, so you would be doing that globally as well. That is a big business opportunity for European companies, apart from anything else.[64]

51. The EU has already started moving towards this type of co-operation, by establishing in September 2005 a programme worth $6 million to transfer carbon sequestration technology to China, but initiatives are still at a tentative stage.[65] While we recognise that the insecurity of intellectual property rights presents a serious obstacle to an effective initiative, any effort to improve energy use in China and reduce environmental degradation is very much in the United Kingdom's interests.[66]

52. We conclude that energy supplies present a constraint on China's economic growth, and that China's need for raw materials and imported energy sources has an impact on the interests of the United Kingdom by driving up demand for oil and other resources. We recommend that the Government explore measures to co-operate on a European level with the Chinese authorities to establish a common framework within which the development of renewable energy and energy efficiency technologies can take place at a greater pace and that it set out in its response to this Report what steps it is taking to do so.

ENVIRONMENTAL DEGRADATION

53. Another serious impediment to continued economic growth in China is steady environmental degradation. China is home to 16 of the 20 most polluted cities in the world, 70% of the state suffers from water pollution, crop returns across the country are decreasing and desertification, particularly in the north east, is expanding.[67] John Ashton told us that environmental degradation "is a significant constraint":

Estimates of the costs to China's GDP vary enormously and each one must be taken with a pinch of salt, but I have seen figures up to 15%. I think the World Bank has estimated something like 8% […] China would be growing twice as fast if it had its environmental stresses under control.[68]

54. The Chinese government has made efforts to curtail environmental degradation, through the State Environmental Protection Agency (SEPA). However, the scale of the task limits its effectiveness; its small staff numbers cannot police the hundreds of thousands of industrial enterprises, while the power of local party leaders with an interest in maintaining breakneck economic growth hampers its work. John Ashton told us: "The trouble is that there are no very easily accessible buttons that Chinese leaders can push that will solve those problems with a sweep of a wand."[69]

55. John Ashton outlined why environmental degradation in China is a matter of importance for the United Kingdom's foreign policy. He said: "It is about recognising that we will increasingly be unable to secure our separate national interests unless we secure our shared global interests; for example our interest in a stable climate."[70] He went on:

It is dangerous to see the internal environmental stresses as in any way separate from the external consequences, the external stresses, which are being catalysed by the way in which China's economy is growing […] If we find a way of engaging China that will help deal with the external stresses, we will also be helping them deal with the internal stresses—if they are using energy and water much more efficiently, for example.[71]

56. The decision by the Chinese authorities to prohibit logging demonstrates the trans-national nature of environmental degradation, since demand for timber still exists in China but is now projected outside its borders. This need has encouraged illegal logging in states such as Burma and Indonesia with all the associated environmental impacts and has also provided a source of income to warlords in Liberia, notwithstanding the preservation of China's forests.[72]

57. This interdependence is most visible on climate change questions. China's greenhouse gas emissions are the second largest in the world but are still relatively low per capita. At present China emits about 12% of global carbon emissions, and its output will increase to about 18% by 2025; but the USA emits about 5.5 metric tones of carbon per person, while China emits 0.6 metric tons of carbon per person.[73] Under the United Nations Framework Agreement on Climate Change, China is a non-Annex I country, meaning it has not agreed to binding emissions reductions in the Kyoto Protocol, which it ratified in 2002; any fall in emissions would be a happy by-product of efforts to improve energy efficiency and security, rather than an end in itself. However, any effort to tackle carbon emissions needs to take place on an international level—and so China's extensive use of high carbon coal undermines efforts in the United Kingdom or Europe to reduce their emissions.

58. Water is another factor of some concern in China. Growing urbanisation is putting enormous demands on supplies, as municipalities such as Beijing, Shanghai, Tianjin, and Chongqing demand water for industrial and consumer needs. SEPA estimates that pollution levels in 75% of China's rivers and 92% of its lakes and reservoirs are high enough to make their water unfit for human consumption, while the northern cities are draining non-renewable ground aquifers, which has led to increasing levels of drought, dust storms and large scale subsidence.[74] In the 11th Five Year Plan China's government dedicated about $61 billion to water related projects. Efforts include plans to reduce water use by 20% in urban areas, and large scale diversification projects are under way to divert water from the Yangtze River north to the Yellow River valley. China is also importing more 'virtual water' in the form of grain and other food imports to sate urban appetites, which, over time, could lead to increases in global food prices.[75]

59. John Ashton said:

There is a close link, I think, between the efficiency of water use in China and the global food economy. The more Chinese agricultural production is hit by shortage of water […] the more that will be an upward pressure on global food prices. On top of that, as China gets richer there is more of an appetite for meat, and producing meat is more water-intensive than producing arable crops. Some of that water intensity is in effect exported. China has become a very large-scale importer of soya, for example from Brazil, for animal feed. In Brazil there are also issues of water stress which are exaggerated if you grow more soya.[76]

60. We asked the Foreign Secretary about the environmental question. She told us:

The Chinese government has shown a very welcome and indeed a more thorough recognition of some of these dangers and the importance of some of these issues than perhaps many others in the developing world […] The reason that the Chinese Government has become engaged in this work is because of their own recognition of how substantial these issues are for the whole length and breadth of China.[77]

We welcome positive engagement from the Chinese.

61. We conclude that environmental degradation is a major impediment to the sustainability of the growth of the Chinese economy, and that the United Kingdom has a strong interest in helping the Chinese overcome internal stresses since they easily translate into external stresses. We further conclude that the United Kingdom and its European partners have a large stake in encouraging the reduction of carbon emissions in China to counter global warming, since any reduction of emissions by the United Kingdom will have a negligible effect if China does not take similar steps. We recommend that the Government increase its support for environmental projects in China, particularly in areas such as water supplies and carbon emissions. We further recommend that the Government provide support to British companies with expertise in areas such as environmental management seeking opportunities in China.

British Business in China

62. Following WTO admission in 2001, new opportunities have emerged for foreign business in China. Dr Yueh said that "following WTO accession, a major source of opportunities will be provided by the opening of China's domestic market".[78] Dr Yueh went on:

Insurance, banking and financial services will be liberalised, though the issue remains one of timing and degree. Geographical restrictions will be removed and foreign banks will be permitted to engage in Chinese currency (renminbi) business by the end of 2006, for instance […] Other areas of WTO-related opportunities lie in education and service professions, such as law and accountancy. The opening of these sectors is significant and follows a trend of increase in global trade in services. For a developed country such as the UK, its trade surplus in services with China—despite an overall trade deficit—is likely to continue and grow.[79]

63. However, James Forder, of Balliol College, Oxford, emphasised the difficulties in doing business in China despite the WTO reforms:

It should never be doubted that China remains a very difficult place to do business. The legal system is developing from a very primitive base; there have until recently been serious concerns about widespread corruption within it; and it is in many respects obscure and confusing to outsiders. At least one British law firm advises its clients of the dangers of falling foul of laws which are actually unpublished.[80]

64. Dr Christopher Dent of the Department of East Asian Studies, University of Leeds, was more optimistic when he said in his evidence that:

China's difficult regulatory environment and lax commercial laws continue to frustrate European, American and other foreign investing firms alike, although the Chinese are making some progress at improving the situation. Corruption levels, while still comparatively high by broad international standards, are reported to be falling significantly. The commercial legal environment is improving too, partly out of intensified competition between provincial governments to attract foreign investment.[81]

65. Notwithstanding the difficulty of doing business in China, some witnesses felt that Britain was lagging behind its competitors. Stephen Perry, Chairman of the 48 Group and Vice-Chairman of the China Britain Business Council, made a negative assessment, saying:

Whilst Germany has a positive trading balance [with China] the UK is in deficit in a ratio of approx[imately] 4:1 in visible trade and is underperforming even on invisible trade […] Over the past five years the UK has underperformed in both goods and services. Only 1.25% of UK total exports are to China and what is more the UK share of the […] total market has fallen, even if the total value of exports has risen. Economists might argue that we are a service economy and since China's services sector is relatively underdeveloped the UK can hope to make its comparative advantage count in years to come. But the figures show that the UK share of total cross border trade in services is 8% but we only have a 2% share of China's service imports. And before you start to think it, trade through H[ong] K[ong] does not even up the figures at all.[82]

66. Caution has been expressed about these statistics. We heard from a range of interlocutors in China that the figures were distorted—Rolls Royce engines, for instance, count as French trade because of their incorporation into Airbus airplanes. We also heard that investment substituted, to some extent, for trade. However, Stephen Perry said:

The UK is the biggest European investor by stock but not by trend—Germany is en route to overtake us soon. And our investment in China accounts for only 1% of their total investment—the real money comes from East Asia and the States. And our investment is heavily skewed. If we strip out Shell, BP and Vodafone who have in the past taken equity stakes in Chinese companies for strategic purposes, our investment level declines by almost 50%. And almost all our investment is concentrated in the Pearl River Delta, Bohai Rim and Yangtze River Delta. If you travel the rest of China you will frequently find Germany and other European investment but not UK.[83]

Lord Powell also told us: "Our market share is 1.3%, which is obviously inadequate—China is Britain's sixteenth export market. Here is the world's fastest growing economy on course to be the third largest before very long and it is our sixteenth market."[84]

67. We asked the Foreign Secretary about this, and she said:

In the past we have not enjoyed as great a share of trade as one might think judging from the share we have of investment in China […] it is my understanding that part of the issue has been that the things that China has most needed in the most recent past have been in the heavy goods/heavy machinery end of things, where, for good or ill […] the fact is that these are not areas where Britain has the strengths that we have had the past.[85]

68. We conclude that the United Kingdom's market share in China is lagging behind its competitors, and that the Government must do more to support British business in China.

69. A coherent Government approach is crucial in supporting British business activity in China. The FCO described Government structures for dealing with China:

The FCO takes the lead in developing UK policy towards China and for ensuring that the work of other groups such as the China and Asian Task Forces are reflected in broader strategy. The Government's strategy on China as a whole is coordinated by the Cabinet Office. It arranges meetings of the Whitehall China officials group, which enables individual Government departments to feed in their views on the Whitehall China strategy and to update others and contribute towards a cross-Government detailed action plan on China.[86]

70. However, Stephen Perry criticised the Government's approach to China:

There is no Whitehall China trade strategy. It is true to say that Whitehall departments meet periodically in the Cabinet Office and detail their respective bilateral initiatives which are then put together under four or five headings. But this is a description of activity with the word strategy imported as a heading…Equally, UK Trade & Investment do not have a China Strategy […] Indeed the China unit which did have a pan-China brief staffed with China hands has been radically reduced in numbers and responsibility restricted to managing overseas posts […] The last couple of years have seen almost all the regions establishing physical offices in China; the mayor of London is setting up offices; the City of London is setting up an office; the CBI is setting up offices. And who is coordinating all of this? No-one.[87]

71. Lord Powell, on the other hand, expressed a more positive view of Government co-ordination. He told us:

co-ordination has improved greatly in recent years for a number of reasons. One has been the establishment of the China Task Force, set up about three years ago. For the first time, all elements of British policy towards China involving not just business but education, health care and cultural matters are drawn together. We are approaching the point where you could say we have a national strategy towards China, which is co-ordinated through a clearing house called the China Task Force. This is a great step forward, and I think the Government deserves a lot of credit for it.[88]

72. The Deputy Prime Minister, who chairs the Task Force explained its role:

The China Task Force was established as a result of my right hon. Friend, the Prime Minister's visit to China in 2003, when he agreed with the Chinese Premier Wen Jiabao that a group should be set up to consider issues of interest to our two countries' bilateral relations […] The Task Force's remit covers trade and investment, education, science and technology, health, culture, environment and sustainable development, and development issues. These areas align closely with the areas identified for cross-departmental action being developed in response to the challenges of globalization.[89]

73. We asked the Foreign Secretary about Whitehall co-ordination on China, and she said:

As to an issue of Whitehall strategy in departments, again this is something that one can always say one can improve […] but there is actually quite good co-ordination between the different departments and the involvement of departments working together to support things like the UK-China Task Force and so on. There is quite a lot of good engagement.[90]

74. We heard that the United Kingdom has not yet signed up to the Shanghai 2010 commercial exhibition (Expo 2010). We asked the Foreign Secretary about this, and she said: "This is an issue that has to go to the Prime Minister but what I can certainly tell the Committee is that I do intend to recommend to the Prime Minister that we should in principle accept that we should be participants in Expo".[91]

75. We conclude that Expo 2010 presents a key opportunity for the Government to support British business in China, and we recommend that the Government sign up to Expo 2010 forthwith. We further recommend that the Government undertake a review of Whitehall structures dealing with China to ensure that they operate together in an co-ordinated fashion, so as to avoid leaving the United Kingdom and its businesses at a disadvantage when dealing with China.

76. A number of organisations support British business in China. The FCO described the structure of support for business as follows:

UK Trade and Investment (UKTI), the China Britain Business Council (CBBC) and the British Chamber of Commerce in China (BCCC) have different and complementary roles in supporting UK business in the China market. UKTI and the CBBC work in partnership to provide a range of business promotion activities for UK companies. These activities are divided between UKTI and CBBC by way of a Service Level Agreement between the two parties. This arrangement enables UKTI to draw on the CBBC's organisational flexibility, expertise and resource in China (and UK) to deliver a wide service in a cost-effective manner. CBBC has nine offices in China, seven in cities where there is no British diplomatic representation. CBBC also provides a range of independent services for UK business. The BCCC is primarily a knowledge accumulation and sharing organisation through its provision of connectivity and networking opportunities for its membership. The Chamber has a small paid staff and no desire or facility to replicate the work of the CBBC and UKTI.[92]

77. Our predecessor Committee in a Report in November 2000 commented on this issue, saying:

We recommend that the British Trade and Investment's long-term trade and investment strategy for China take account of the potential overlaps between the CBBC, the diplomatic posts' commercial work, and the Chambers of Commerce in China, and should aim to eliminate duplication.[93]

78. We asked Lord Powell, the President of CBBC, about this arrangement. He told us:

it is fair to say there has been improved co-operation between UKTI, which of course is the Government's trade promotion body generally, and the China Britain Business Council. We have a service level agreement with them, which describes exactly what the Government expects of the China Britain Business Council, as well as of course what business expects of it. That enables us to work very closely with UKTI without duplicating what they are doing. That coordination also extends into China where we have a clear understanding with the Embassy and the consulates-general what they do, particularly what I would call the higher level work, the policy work, ministerial visits work, and what the China Britain Business Council does, which is to deliver the basic commercial trade promotion services.[94]

79. CBBC shares an office with the British Chamber of Commerce in Beijing which has aided effective co-operation between the two organisations. Lord Powell described the role played by the CBBC in encouraging British businesses to enter the China market. He said: "In the China Britain Business Council, we run a programme called Take the China Challenge, which goes out to different regions, spends a day, invites in smaller and medium sized companies."[95] We heard in Shanghai that the CBBC does provide a useful service, since its geographical spread means its people can offer services to British companies where there is no diplomatic representation.

80. However, one consequence of this system is that businesses operating in China have to join several organisations, adding costs and complexities to their efforts to enter the Chinese market. The presence of the United Kingdom's Regional Development Agencies adds to the confusion. Yet the Foreign Secretary defended the arrangement when we asked her about it. She said:

I can understand […] in the business community there is a tendency to want…one kind of simple channel, but China, as you have seen for yourselves, is a large and very complex place and what we have at present is not a plethora of bodies but we have a number of different bodies, each of whom play a role which is slightly distinct […] It appears to me […] there is quite a good working, constructive relationship. They are not competing with each other.[96]

81. We conclude that the Government must seek to ensure that lines of responsibility between UK Trade and Investment, the China-Britain Business Council, the British Chambers of Commerce and Regional Development Agencies are clear and that there is no duplication of work, so that smaller businesses seeking to 'take the China challenge' do not face duplication of costs and services provided by the range of organisations. We recommend that the Government increase the number of high level ministerial visits to China in support of British business.

82. In addition to these structural questions, submissions have emphasised the need for the UK to step up language training if British companies are truly to take advantage of opportunities in China. The Great Britain China Centre and the China Media Centre at the University of Westminster stated in evidence that "research by the British Association for Chinese Studies has demonstrated just how little knowledge of China, or study of the Chinese language, takes place in UK schools" and that "we need to think seriously about encouraging widespread Chinese language study in our schools".[97]

83. Don Starr, Head of East Asian studies at the University of Durham, also stated:

Britain's poor record in studying the languages and cultures of East Asia is impacting negatively on our effectiveness, particularly in business […] British universities have gone from having some of the most extensive and highest quality East Asian language and culture programmes in the world to languishing behind other European countries, the US and Oceania. This reflects the way governmental bodies charged with overseeing skills needs have consistently under-rated the importance of language skills and been unwilling to pay for them.[98]

Lord Powell agreed that the lack of expertise was a problem. He told us: "There is a very big problem in that the number of Chinese speakers and the amount of Chinese studies in this country are quite clearly inadequate."[99]

84. We asked the Foreign Secretary how to improve this. She told us:

In the UK there is a quite substantial […] and growing area of study. There is the educational co-operation programme with schools in China […] Just under 2,000 15-year-olds were entered for a GCSE in Chinese in 2005 and just over 1,600 16 to 18-year-olds were entered for a GCE A level.[100]

85. We conclude that the United Kingdom must attain greater proficiency in East Asian languages and cultures or face a diminution of influence in a very dynamic region. We recommend that the Government redouble its efforts to support the teaching of Chinese and other East Asian languages in schools and universities in the United Kingdom.

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9   Vanessa Rossi, "The Chinese Economy: Risky reporting", Briefing Paper, The Royal Institute of International Affairs, April 2005 Back

10   Judith Kornberg and John Faust, China in World Politics, (London 2005) Back

11   Ev 113 Back

12   Q 6  Back

13   Q 65  Back

14   "China's Economic Growth And Its Global Impact", Report on Wilton Park Conference, Monday 31 October - Thursday 3 November 2005, available at http://www.wiltonpark.org Back

15   Ev 17  Back

16   World Trade Organisation, International Trade Statistics 2005, Table 1.5, p 21 Back

17   Q 19 Back

18   Q 19 Back

19   Linda Yueh, "The economy: opportunities and risks", China and Britain: the potential impact of China's development, Smith Institute, 2005, p 37 Back

20   Q 19 Back

21   Q 117 Back

22   Ev 264 [Professor Schenk] Back

23   Q 83 Back

24   Ev 180 Back

25   Ev 264 Back

26   Linda Yueh, "The economy: opportunities and risks", China and Britain: the potential impact of China's development, Smith Institute, 2005, p 37 Back

27   Q 236 Back

28   Ev 264 Back

29   Ev 182 Back

30   Stephen Green, "China's quest for market economy status", Briefing Note, The Royal Institute of International Affairs, May 2004 Back

31   "EU approves textiles deal", BBC News Online, 7 September 2005, news.bbc.co.uk Back

32   Q 28 Back

33   "Mandelson child shoe levy 'will hit the poor'", Daily Telegraph, 6 July 2006 Back

34   Qq 236-8 Back

35   Jamestown Foundation, China Brief, 22 November 2005, Volume V, Issue 24 Back

36   "Economic and Financial Indicators", The Economist, 25 February 2006 Back

37   "US launches new task force on China trade", China Daily, 15 February 2006 Back

38   "Emerging market indicators", The Economist, 3 June 2006 Back

39   Albert Keidel, "China's currency: not the problem", Policy Brief,Carnegie Endowment for International Peace, June 2005 Back

40   Q 151 Back

41   Q 151 Back

42   "Whither China?", Speech by Robert Zoellick US Department of State, 21 September 2005 Back

43   EU-China Summit: Joint Statement, European Commission, 5 September 2005 Back

44   Q 22 Back

45   Q 274 Back

46   Q 274 Back

47   Q 66 Back

48   Ev 265 Back

49   Ev 125 Back

50   Q 69 Back

51   Q 69 Back

52   Q 67-70 [Dr Yueh] Back

53   Ev 264 Back

54   Ev 113 Back

55   Ev 265 Back

56   Q 113 Back

57   Q 75 Back

58   Ev 263 Back

59   Ev 114 Back

60   "China: Environmental Issues", Country Analysis Brief, Energy Information Administration, US Department of Energy Back

61   Ibid Back

62   Q 208 Back

63   "China: Environmental Issues", Country Analysis Brief, Energy Information Administration, US Department of Energy Back

64   Q 221 Back

65   "China: the sky darkens", Le Monde Diplomatique, April 2006 Back

66   See above, Para 29 Back

67   Jamestown Foundation, China Brief, October 2005, Volume V, Issue 22  Back

68   Q 214-215 Back

69   Q 216 Back

70   Q 208 Back

71   Q 211 Back

72   Q 220 [Mr Ashton] Back

73   "China: Environmental Issues", Country Analysis Brief, Energy Information Administration, US Department of Energy Back

74   "China: The Worth of Water", World Markets Research Centre, 24 March 2006 Back

75   Ibid Back

76   Q 230 Back

77   Q 263 Back

78   Linda Yueh, "The economy: opportunities and risks", China and Britain: the potential impact of China's development, Smith Institute, 2005 Back

79   Ibid Back

80   Ev 243 Back

81   Ev 182 Back

82   Ev 193 Back

83   Ev 193-4 Back

84   Q 125 Back

85   Q 245 Back

86   Ev 132 Back

87   Ev 194 Back

88   Q 116 Back

89   HC Deb, 23 May 2006, col 1664W [Commons written answer] Back

90   Q 243  Back

91   Q 239 Back

92   Ev 132 Back

93   Foreign Affairs Committee, Tenth Report of Session 1999-2000, China, HC574-I, para 138 Back

94   Q 116 Back

95   Q 119 Back

96   Q 242 Back

97   Ev 236 Back

98   Ev 231-2 Back

99   Q 121 Back

100   Q 246 Back

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Prepared 13 August 2006