China is increasingly the focus of U.S. trade and investment. It is also increasingly achieving the goal that its leaders have set for it – to become the manufacturing platform for the world. In December, the inventor of the personal computer, IBM, announced that it was selling its PC business to Lenovo, China’s largest personal computer maker.  During 2004, Boeing announced that it would be manufacturing a large percentage of its new 7E7 “Dreamliner” in China, including sophisticated carbon fiber components. Corning Glass, which already has seven plants in China, announced another $1 billion investment to make the components for flat panel displays. General Motors announced its intention to invest $3 billion more in China over the next few years. And the list goes on. 

With its low wages and increasingly skilled workforce, with its tremendous 1.3 billion person internal market, and with its undervalued currency, China would seem to be a highly attractive investment opportunity.  But there are many uncertainties as well.  First and foremost, there is the question of how long the Chinese currency, the yuan, will remain undervalued. When its inevitable revaluation comes, or the decision is made to float it against a basket of currencies, many of the current economic assumptions could change dramatically. 

In this column, I would like to focus on another important area of uncertainty, the question of export control restraints on China trade. Export controls may not seem very important, but failing to meet the export control criteria can be a “show-stopper.” As the technology transfer involved in prospective investment decisions becomes more and more sophisticated, I would argue that the U.S. government would not be eager to see such technology transferred to China in particular. Consider just two examples.

The PC has become a commodity. That is why IBM wants to get out of this highly competitive manufacturing segment. But in the age of ever more powerful microprocessors, U.S. export control officials will ask what exactly is the upper limit of technology that IBM will be teaching the Chinese to manufacture, and what is that level’s relevance for even higher levels? Both the international Wassenaar Arrangement and U.S. export control regulations set a lower threshold for the transfer of computer manufacturing technical data than for the finished product. The U.S. Government is bound to ask – and likely to debate internally — what would be the spillover to the military sphere in China from IBM’s assistance?

China, with the potential to consume as much as 25 percent of Boeing’s future sales and with at least four sophisticated and integrated aircraft factories available, staffed by workers earning one-tenth of their counterparts in the United States or Europe, would seem to be an ideal place to manufacture major components and sub-sections of the new 7E7 (as well as its latest generation Airbus counterpart).  Nevertheless, it is hard to imagine the Defense Department not raising major questions about the transfer of the carbon fiber technology that is projected to constitute more that 50 percent of the weight of the new jet. Carbon fiber plays a major role in making aircraft light and maneuverable, military as well as civilian. As noted in earlier columns, DoD is still raising objections to the export of five-axis machine tools that are necessary for the manufacture of the current generation of Boeing and Airbus aircraft, despite the fact that the Chinese themselves now produce such machines. That would lead one to fear that there is likely to be a prolonged debate before the U.S. government has a sufficient comfort level about carbon fiber technology transfer.

I wonder if Boeing (and IBM) have factored the technology transfer debate into their business plans for China. Unfortunately for U.S. exporters and investors, the European Union countries see China much more as a vast and attractive market and as a low-cost alternative to their rigid and costly labor structure, than as a strategic threat. While the United States, as the leading military power in the world and as a Pacific as well as an Atlantic power, invariably views China from a strategic military as well as a commercial point of view. This means that military and strategic concerns frequently intervene in what would seem to corporate America as a purely commercial question:  “Do the economic rewards justify the economic risks?” The U.S. government, however, is likely to be asking a parallel question:  “Do the economic benefits justify the strategic risks, and are the strategic risks acceptable no matter what the economic benefits are?”

Let me be clear. My answer to that question would be yes. I am not sure that the Bush Administration will come to the same conclusion in a reasonable time frame. I believe, however, that they will eventually come to that conclusion — after the Europeans have taken advantage of our indecision to gain still more market share.

Other Public Policy Issues:

* President Bush has appointed a nine member advisory panel to recommend a revenue neutral tax reform proposal to the Treasury Department by July 31st. Former Senators Connie Mack (R-FL) and John Breaux (D-LA) will chair the panel.  Key proposals the panel will consider will be tax-free savings accounts for individuals and expensing/depreciation reform for businesses. Former Cong. Bill Frenzel (RMN), who is honorary co-chair of the Center for Strategic Tax Reform (CSTR) of which AMT is a founding member, is a member of the panel.

* The European Union (EU) has finally agreed to terminate the 14 percent punitive tariffs against U.S. machine tool and other exports to Europe that were imposed as retaliation against the Foreign Sales Corporation (FSC-ETI) export tax benefit, which Congress repealed last year. The EU says that it will rebate tariffs collected in January 2005. The Europeans, however, still object to FSC-ETI transition rules enacted by Congress last year. They filed a legal action with the World Trade Organization (WTO) asking it to review the rules.  If the WTO finds in the EU’s favor later this year, the 14 percent punitive tariffs could resume for 60 percent of the products on the original retaliation list. It’s still up in the air as to whether machine tools would be included.

* Senate Majority Leader Bill Frist (RTN) has introduced a bipartisan compromise class action reform bill that removes most class action lawsuits against businesses from several notoriously pro-plaintiff state courts to federal courts. Sen. Frist plans to move the bill, a top Bush Administration priority, to the Senate floor the week of February 7th after a Senate Judiciary Committee markup this week. Senate Democrats, who blocked passage of a similar House-passed bill last year, have apparently agreed not to offer controversial, nongermane amendments (e.g., minimum wage and overtime protections), if the bill retains its bipartisan provisions through the Judiciary Committee markup. This is the first bill on the GOP litigation reform agenda. The Senate is expected to take up medical malpractice reform this spring; and Senate Judiciary Committee Chairman Arlen Specter (R-PA) is working on a compromise Asbestos Compensation bill.