China trade troubles: More than just currency

National security concerns always trump economic concerns. In 2004, the bilateral U.S. trade deficit with China totaled $162 billion. If economics were driving policy in the U.S. Government, every effort would be made to diminish that trade deficit by increasing exports to China in every way. Instead, the Commerce Department's Bureau of Industry and Security is contemplating new regulations that are guaranteed to diminish U.S. manufactured exports to China by a significant amount, particularly in the metalcutting and forming sector.

While testifying before the House Armed Services Committee, Acting Commerce Department Under Secretary for Export Administration Peter Lichtenbaum committed to Chairman Duncan Hunter (R, Calif.) that he would draft regulations that would keep U. S. companies from doing business with the Chinese military. That commitment sounds simple enough, but it has broad implications.

Currently, exports to Chinese military end users are not prohibited, unless the end user is engaged in manufacturing weapons of mass destruction (or certain other prohibited activities). However, early drafts of the proposed new regulations could potentially cut off a great deal of the business that is currently taking place.

Although the final regulations have not been revealed to the public, the proposed definition of the Chinese military and the parameters of doing business are vague. In its current form, the regulations would almost certainly deter companies from doing business with Chinese entities that might possibly be suppliers to the Chinese military. This would impact even companies that are neither Chinese military entities nor principal suppliers to the military.

In the legislative arena, the House Armed Services Committee, chaired by Rep. Hunter, inserted a controversial provision into the Defense Authorization bill for Fiscal Year 2006. It is designed to signal to European Union companies that they could choose between supplying military equipment to the Chinese military or the U.S. military, but not both. It stipulates that any company that supplies the Chinese military with any item (or a comparable item) that is on the U.S. Munitions List would be prohibited from participating in procurement contracts with the Defense Department for a period of five years. The prohibition on procurement would be applied to the subsidiaries of foreign parent companies that violated the ban, which would affect such multibillion dollar companies operating in the U.S. as BAE and EADS.

Exceptions are made only for existing contracts and procurement essential to U.S. national security. It is likely that the proposed regulations and the legislative provision are designed to provide credibility for an initiative by the Administration to induce the EU countries to adopt similar "China military catch-all" regulations. This would explain the pressure to get these regulations in place while the EU is debating the lifting of the Tienamen Square sanctions against doing business with the Chinese military. But both the legislation and the regulation are likely to have deleterious consequences for the industrial sector in the U.S.

Europeans are likely to interpret any prohibition against doing business with the Chinese military more narrowly than the U.S. Without reliable information or more precise definitions, U.S. companies are likely to cut off trade with many previously acceptable Chinese factories. If U.S. companies go ahead and ship, they run the risk of violating the law. Finally, if the legislation passes, EU companies faced with possible loss of the U.S. market for doing business with the Chinese military will be that much less open to using American equipment, or buying American parts and components. Whatever the national security justification, the trade implications are direct and negative.