Taking Stock of the Strategic and Economic Dialogue

Nicholas Borst (Federal Reserve Bank of San Francisco)



Last week’s high-level bilateral meeting between the United States and China came during a time of increasingly tense relations between the two great powers. A mix of competition and cooperation has always characterized the relationship, but the balance of these two elements has shifted in recent months. Territorial disputes with American allies and an ongoing cyber conflict are the primary factors behind the increasingly tense Sino-American relationship. Given the overall state of the relationship, few were expecting a large breakthrough in the economic track negotiations of the Strategic and Economic Dialogue. Those expectations were mostly proved justified by the outcomes detailed in the joint fact sheet issued after the summit.

In recent months, the issue of the bilateral exchange rate has once again reared its head. While the depreciation of the renminbi this year has been modest in comparison to other emerging market currencies, it represents a stark change from the trend of gradual appreciation that has been underway since 2005 (albeit with a few interruptions). Reacting to pressure from Congress and a suspicion that China may be engaging in competitive devaluation during a period of economic weakness, the US Treasury has been pushing for an end to Chinese government intervention in the foreign currency markets.

The Chinese position has been that movement in the exchange rate is primarily market-driven and it is natural that there will be two-way movement because the currency is close to equilibrium. Moreover, the People’s Bank of China reserves the right to intervene in the foreign exchange market in order to combat what it views as excessive hot money inflows.

The language of the joint fact sheet reveals something of a draw was achieved on the issue. The Chinese agreed to “reduce foreign exchange intervention as conditions permit.” This language allowed the American side to claim victory while requiring little in the way of action from the Chinese. In fact, the commitment to end normal foreign exchange intervention is a preexisting policy goal expressed by Zhou Xiaochuan last fall.

China also made a minor commitment on one of the long standing pet peeves of the U.S. Treasury, the refusal of the People's Bank to report foreign exchange intervention via the IMF’s Special Data Dissemination Standard (SDDS). The US wants China to adhere to this reporting standard because it requires more timely notifications on intervention actions by the Chinese central bank. The Chinese agreed to “make technical preparations” to join the program, an upgrade from last year’s commitment to “actively consider” the SDDS.

The other major issue on the economic agenda is the bilateral investment treaty (BIT). The biggest breakthrough from last year’s strategic and economic dialogue was China’s agreement to negotiate a high-standards BIT with a negative list approach to investment approval. Accepting the framework of a negative list, meaning investments in all sectors not explicitly prohibited are permitted, represented a sea change in the Chinese approach and has the potential to significantly increase market access for foreign firms.

This year’s announcement on the BIT contained no major breakthroughs, but did set out more concrete goals for the negotiation process. The two sides will “reach agreement on core issues and major articles of the treaty” by the end of 2014 and “initiate negotiation” in early 2015 on the specifics of the negative list. That negotiations remain in such an early stage a full year after last year’s announcement is a disappointment.

There were a few other areas of progress that emerged from the negotiations. China committed to let the market play a larger role in determining prices in several important sectors, including petroleum, electricity, and natural gas. While these do not represent concessions because they were part of last fall's Third Plenum, it is a positive step to reaffirm these commitments in an international setting. The same is true for the pledge to remove restrictions to foreign investment in several sectors, including child and elderly care, architectural design, accounting and auditing, commerce and logistics, and electronic commerce.

The economic relationship remains strong and mutually beneficial, but the scope for expanding cooperation is limited by a fundamental asymmetry. The American market is more or less open to the rest of the world and therefore there is little the Americans can “give” to the Chinese. In contrast, large swathes of the Chinese economy remain off-limits or partially restricted for foreign enterprises. Therefore most of the concessions are from the Chinese.

On two of the issues the Chinese care deeply about, reforms to the CFIUS process and approval of the IMF quota reform, the American side is unable to deliver results. These actions require the cooperation of the Congress, which the Obama administration is unlikely to receive even if it decides to make these issues a high priority.

This leads to the larger question of how much we can expect from the bilateral economic relationship in the near term. Trade and investment will undoubtedly continue to grow, but both sides will continue to make economic policy based primarily off domestic considerations, irrespective of the text of joint statements. The new Chinese administration appears committed to reform, but these new policies are likely to be rolled out in a gradual and selective manner. This will be a continual source of frustration for American policymakers. The scope for cooperation at the global level is also limited. New international initiatives by the Chinese, such as the proposed Asian Infrastructure Bank, are likely to receive a lukewarm reception from the US.

After several years of high expectations for the Strategic and Economic Dialogue, the bilateral economic relationship has reached a stable, less dynamic steady state. Negotiations will proceed apace, but progress will be incremental rather than transformative. The limited scope of the economic partnership is not inherently bad, but it raises concerns whether it can continue to be the glue that holds together the overall relationship in light of the deteriorating strategic relationship. Revitalizing the dialogue will take a commitment by all sides, including the Congress, to raise the bar and expand the scope for a true economic partnership.

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