I. COMMERCIAL OVERVIEW In recent years, the People's Republic of China (China) has had one of the fastest growing economies in the world. Its gross national product (GNP) increased over 13 percent in 1993 and is projected to continue to grow at 8-9 percent annually through the end of the century. Foreign trade as a percentage of China's GNP now accounts for nearly 40 percent. Certain regions in China -- especially those along the coast -- are booming, and many people are becoming more prosperous. Guangdong province, China's most open region with a population of 65 million, benefits from neighboring Hong Kong's free-wheeling capitalist economy, and the movement of Hong Kong's manufacturing sector into the province has created probably the most dynamic economy in the world. Rapid economic growth, bold reform measures and massive infrastructure plans point to enormous market potential in China. Chinese leaders have projected spending of at least $100 billion per year on imports from now until the year 2000. As China gives priority to infrastructural development, business opportunities seem especially promising in the energy, telecommunications and transport sector. Foreign direct investment is pouring into China. According to China's State Statistical Bureau, contracted direct foreign investment, which measures the commitment of private foreign funds to Chinese projects and joint ventures, for 1993 amounted to $111 billion, an increase of 91 percent over 1992. Actual, paid-in foreign direct investment increased by $26 billion, up 130 percent. From the United States alone total contracted investment for 1993 was $5.21 billion. By the end of 1993, over 170,000 foreign-invested enterprises had registered in China, an increase over 1992 of almost 85,000. Cumulative utilized investment since China's opening in the late 1970's reached $61.8 billion, and total contracted foreign investment amounted to $220 billion, by the end of 1993. The United States is China's third largest investor in terms of contracted investment, after Hong Kong and Taiwan. Finance for international business, while never sufficient to cover all of the nation's needs, is available as never before (see Section VIII). With the numbers such as they are, it is no wonder that the World Bank's purchasing power parity evaluation of its GNP placed China as the world's third largest economy. Some predict that China could well be the world's largest economy, displacing even the United States in total GNP, within 30 years or so. China is becoming a major trading nation that United States companies can neglect only at the risk of losing a key world market and, with it, their ability to compete in global markets. A. U.S.-China Trade After a 20-year hiatus, trade between the United States and China resumed in 1972 and developed rapidly after normalization of diplomatic relations in 1979. Two-way trade increased from $2.3 billion in 1979 to $40.3 billion in 1993. U.S. trade with China has been in deficit since 1983. In 1993, Chinese imports from the United States increased roughly 24 percent over 1992 figures. At the same time, the deficit with China reached an historic high at $22.8 billion in 1993, second only to the U.S.-Japan trade deficit. In the first three months of 1994, the U.S. deficit with China reached $5.2 billion, up 24 percent as compared to the same period in 1993. U.S. exports to China developed unevenly after 1979. In 1993, China was the 13th largest foreign market for U.S. goods, with a 1.9 percent share of total U.S. exports. At $8.8 billion in 1993, U.S. exports to China were led by aircraft and parts, motor cars and vehicles, fertilizer, electric machinery and computers, wheat, wood, turbines, scientific instruments, organic chemicals, plastics, iron and steel, and pulp and paper. Unlike exports, U.S. imports from China have grown almost without interruption, from $592 million in 1979 to $31.5 billion in 1993. In 1993, China was the fourth largest exporter to the United States, supplying 5.4 percent of U.S. total imports. The commodity composition of U.S. imports from China has also changed significantly in recent years. Since 1990, leading imports from China have included toys and games, footwear, apparel, leather articles, telecommunications equipment, and electrical machinery and appliances. The Chinese have a high regard for American products and technology and want to see more American companies in the market. Potential for U.S. exports to China has been enhanced greatly by recent bilateral agreements. The U.S.-China agreement on the protection of intellectual property rights led to significant upgrading of China's IPR laws, and the two countries are working together on improving IPR enforcement. Under our 1992 memorandum of understanding on market access, China has begun to publish all its trade-related legislation, and to substantially reduce import tariffs, quotas and licensing requirements. B. Major Business Opportunities A brief review of China's plans for the development and expansion of several key industries reveals the scope of the commercial opportunities now emerging in China. -- Electric Power (Thermal): The Ministry of Electric Powers plans to add 15,000 MW per year to China's power generation capacity over the next ten years. Central and provincial expansion plans include the construction of over 35 power stations between 1992 and 1996. -- Electric Power (Hydro): Most hydro-power projects are joint endeavors between the Ministry of Power and the Ministry of Water Resources. Current plans envision the construction of four huge projects: Three Gorges, to be the largest hydro-power dam in the world, in Hubei Province; Xiaolongdi in Henan Province; Longtan in the Guangxi Autonomous Region; and Ertan in Sichuan Province. -- Railways: China is receiving loans from the World Bank, the Asian Development Bank and the OECF to build and expand six rail lines and to import communications networks, intermodal container transportation and loading systems, computer and signaling systems, software and track maintenance equipment. -- Air Traffic Control and Airport Construction: The Civil Aviation Authority of China (CAAC) is in the midst of a major airport upgrade plan, financed by the OECF. In the summer if 1993, CAAC completed a tender that supplied 52 airports all over China with new radar, instrument landing and communications systems. A second tender for more radar, weather radar, satellite network communication systems and other equipment was conducted last year. A third OECF tranche for air traffic control is expected later this year. -- Municipal Transportation: There are at least four major subway projects now either under way or in the planning stages: Although American companies won only a small portion of the Guangzhou Metro, there are still new systems on the way: the Shenyang Light Rail, a new Qingdao Metro, a new subway for Nanjing and an expansion of the Beijing Metro system. -- Telecommunications: The Ministry of Posts and Telecommunications plans to install: 12 million new telephone lines per year, for a total of 100 million by the year 2000; plus 1.2 million long distance circuits by 1995, and 3.5 million by the year 2000. Other plans for the next five years include the installation of 32,000 km of optical cable lines. -- Metallurgy: The target under China's eighth five-year plan for steel production this year is between 78 and 80 million tons. Production is to be raised to 100 million tons per year by 2000 and to 120 million tons per year by 2005. To help achieve these goals the government has approved the construction of three new steel complexes at Jinan, Jilin Province, Zhanjiang, Guangdong Province and Ningbo, Zhejiang Province. Three existing plants have been approved for expansion: Baoshan in Shanghai, Anshan in Liaoning Province and Capital Iron and Steel in Beijing -- Energy: One of the major threats to China's ability to sustain its current high-speed growth is the chronic shortage of energy. It is no wonder then that one of the highest priorities of all development planning is the efficient exploitation of China's energy resources. The Government will be looking increasingly to foreign companies for investment, technology and equipment. In addition to the offshore exploration blocks already open to foreign companies, the Chinese government has opened important areas for onshore exploration and development, including the most important of all, the Tarim Basin in Xinjiang Province. -- Building Materials: In order to increase the production of cement to fill China's ever expanding construction industry, three plant expansion projects have been approved, at Yichang, the site of the Three Gorges project; at Zhicheng, near Wuhan in Hubei Province; and at Wanxian, Sichuan Province. -- Environmental Protection: China still lacks the financial strength to undertake strict enforcement of environmental standards. Nevertheless there are some significant environmental projects planned mainly for air pollution control and for municipal water treatment and purification. Sixteen water treatment projects are planned for several points along the Yangzi River alone. An experimental incinerator is being built in Guangzhou and various clean coal technologies are being included on a trial basis in power projects in several provinces. MOEP is planning to use $200 million from the Asian Development Bank to raise the efficiency and environmental protection standards in a large matrix of power plants in the Northeast. -- Factory Renovations: China's traditional state-owned heavy industrial base is in serious need of technological renovation. Central government approval has been granted for the renovation and expansion of hundreds of industrial enterprises in Harbin in Heilongjiang Province, Shenyang in Liaoning Province, Shanghai and Chongqing in Sichuan Province. These enterprises have been authorized either to import new technology and equipment directly or to enter into joint ventures with foreign companies. Major market opportunities exist in many other sectors as well, including notably aircraft, computers, electronics, automotive components, chemicals and medical equipment. See Chapter II and, for details on best market prospects, Appendix B. C. Exploiting the Opportunities Finding and winning projects is not always an easy matter. One must know how the market operates and where trends are leading. First, China is becoming an increasingly fragmented market of regions. What used to be a more or less unified national market has now become a number of regional markets, each pursuing its own development strategy, each competing with the others to attract foreign investment and technology. The most dynamic and most successful region is in the south, especially Guangdong and Fujian Provinces, where reforms have been pushed the farthest and strong ties to Hong Kong and Taiwan have been developed. Shanghai and the Yangtze river delta area is another region where economic growth is taking off and where bold new reforms are under experimental implementation. The heavy industrial heartland of China is in the northeast, the region with the densest concentration of state owned industrial enterprises. A traditional area of strategic interest to China's neighbors, Japanese and Korean investment is dominant, especially in Dalian. New trading linkages are growing along the border with Russia, which has on offer large quantities of outdated but cheap machinery, much of which is entering China via straight barter trade. Second, China's modernization strategy has favored the eastern coastal provinces in that the opening to international trade and investment benefit these areas directly and the inland provinces rather more indirectly, although a small portion of foreign investment has gone inland, particularly in natural resource extraction. Nevertheless, these areas are also in the thick of the reform program. Third, market and regional decentralization have brought about a sort of economic montage, with each region pursuing its own interests and with local governments and enterprises gaining greater autonomy day by day. Some 8,000 companies now have import and export rights. Markets are developing rapidly. The national economic plan determines less and less each year, and sales of commodities and imports of equipment and technology flow ever more freely. Investment in wholly foreign-owned or joint venture companies is actively sought by every region of China. Investment zones with special incentives, each vying to outdo the others, are the vogue nationwide. This complicated montage has two layers. The five-year economic plans have not been entirely done away with, and the central planning bureaucracy still exists. So, there are really two levels to the market in China, one inside the scope of the government economic plan, the other outside. Projects over $10 or $30 million, depending on the regional approval authority, still need central government approval. All of the projects financed by multilateral financial institutions or by foreign governments must also be approved by the State Planning Commission. Most of the heavy industrial sectors are still controlled by the central government, even if rather more loosely than in the past. The plan is also an important channel for state investment funds into priority industries and projects. Energy, petrochemicals, transportation, communications, electronics, agriculture, water conservation and industrial enterprise renovation are the key targets. Fourth, the forward momentum of these forces of regionalization and marketization is being accelerated by yet another force: trade liberalization. This trend is likely to continue both in response to international pressure for more open markets and as an imperative of the reform program itself. The transition to a market-oriented economy will require greater openness to international trade and investment. D. Major Roadblocks to Doing Business In addition to the above macro factors affecting doing business in China, China's current "socialist market" economic structure continues to erect other roadblocks to doing business in China. Apart from relatively high tariffs, sometimes inconsistent application of a 17 percent value-added tax on most imports, and some remaining import quotas and licenses, these include limitations on the right of foreign companies to directly access China's retail market, through local offices or directly hired sales forces; foreign exchange controls; an inefficient banking system; standards and quality control requirements; and continued lack of transparency in the trading system. Other problems include lax enforcement of intellectual property laws, very restricted access for foreign services, and an inadequate system for dispute resolution. These issues are discussed in more detail in Chapter III.