Briefing by Harding and Lardy

Office of the Press Secretary

For Immediate Release June 22, 1998


The Briefing Room

12:10 P.M. EDT

COLONEL CROWLEY: Good afternoon. Last fall, rightbefore President Jiang Zemin came here to Washington in October, wehad what proved from your standpoint to be an enormously beneficialbriefing with Dr. Harry Harding and Dr. Ken Lieberthal to help putthe renewal of high-level contacts between the two countries incontext.

So back by popular demand, and with a slightly newtwist, we thought in preparation for the President's departure onWednesday and, many of you, your departure tomorrow, that we onceagain invite a couple of our scholars back to the present situationin context one more time.

So we have for you once again, a man who said, jeez, Ishould have quit while I was ahead last fall, Dr. Harry Harding ishere. He's the Dean of the Elliott School of International Affairs,and Professor of Political Science and International Affairs atGeorge Washington University. And joining him is Dr. Nicholas Lardy,senior fellow in foreign policy studies at the Brookings Institution,and a leading authority on the Chinese economy.

We'll have Dr. Harding start off with a little politicalcontextual issues, and then Nick will follow with some elements ofthe economic aspect of the relationship, and then we'll take yourquestions.

DR. HARDING: Thank you very much and good afternoon,everyone. It's a great honor for me to be asked again to providesome background, this time on the President's visit to China -- hisfirst trip to the Chinese mainland and the first presidential visitsince President Bush's trip in early 1989.

To me, the most important aspects of China for all of usto understand are its diversity and its dynamism. And the Presidentshould see both of these in ample measure on his trip. As the nationwith the biggest population on earth and one of the largestterritories, China has always been a land of huge contrasts --between the dry north and the wetter south, between the coast and theinterior, between its cities and its countryside, between rich andpoor.

And these longstanding contrasts are being exacerbatedby more recent changes. Today's China is undergoing at least threehistoric transitions simultaneously: an agricultural society isbeing modernized into an industrial one; an ossified Marxist-Leninistpolitical and economic system is being reformed into something moreopen; and a country that has been relatively isolated is beingintegrated with the rest of the world.

Now, of course none of these transformations iscomplete, and all of them carry significant dilemmas and risks.Economic growth is straining China's physical infrastructure.Industrialization is bringing enormous environmental pollution. Thedismantling of old institutions and the discrediting of oldideologies has produced at various times inflation, unemployment,corruption, uncertainty, and ruthlessness.

The new political and financial institutions beingformed to replace the old are variously inadequate or untested. Theintegration of China with the rest of the world is challengingChina's longstanding belief in unfettered national sovereignty.

Now, this combination of dynamism, diversity, anddilemmas makes China extraordinarily difficult for us scholars tounderstand and for you journalists to report. It confounds those whowish to describe the country in overly simple terms. It complicatesour ability to forecast China's future. At any given time, past orpresent, China usually confronts us with both the noble and the base,the inspiring and the depressing, the hopeful and the pessimistic.

I hope that the President's visit to China willintroduce him to the complexity of that country, and the cities thathe will visit promise to do so. Xian is of course the site of one ofChina's most impressive historic sights -- the underground armies ofterra cotta warriors. This extraordinary archaeological excavationis truly one of the wonders of the ancient world, although also areminder of the cruelty of some of China's ancient dynasties.

But Xian is more than this. It's also in the middle ofone of the poorest parts of the country. Nature has not beenparticularly kind to northwest China, and the poverty in thecountryside around Xian illustrates the vast and difficult task ofdeveloping rural China.

Increasingly, China's leaders have understood the needfor local political reform as part of that effort. They understandthat, unless village government is seen as legitimate by its people,it cannot mobilize the human and financial resources needed topromote modernization. They also appear to understand that thatlegitimacy must come through some form of local elections.

Local elections in China are like almost everything elsein the country -- extremely diverse, ranging from the tightlycontrolled to the genuinely competitive. But they represent anelement of political reform that holds considerable promise for thefuture of China.

The President's next stop, Beijing, has been China'scapital since the latter part of the Ming Dynasty, except for a20-year period earlier in this century. And the heart of thecapital, Tiananmen Square, has been the site of major politicalevents throughout this century: the calls for modernization anddemocracy during the May 4th movement of the late 1910s and early'20s, the celebrations marking the establishment of the People'sRepublic in 1949, the mobilization of vast armies of workers to buildthe Great Hall of the People during the Great Leap Forward of1957-58, the Red Guard rallies of the Cultural Revolution, thespontaneous popular movement to mourn the death of Chou En-Lai andcriticize the Gang of Four in 1976, the jubilant celebrations afterthe fall of the Gang of Four later that year, and of course the firstinspiring, and then the tragic, events of the spring of 1989.

Perhaps no other place in China better symbolizes theturbulent course of modern Chinese history, both for better and forworse, than does this one spot.

In Beijing the President will be meeting with Chineseleaders both high and presumably somewhat lower. The succession toDeng Xiaoping, who died just about a year ago, has gone remarkablysmoothly. Jiang Zemin is clearly not the transitional figure thatsome observers once believed him to be. He is rising in stature andhas recently been reconfirmed in his positions as President of thePeople's Republic as well as General Secretary of the ChineseCommunist Party.

The new Prime Minister, Zhu Rongji, appointed earlierthis year, has an impressive commitment to restructure the bankingsystem and the state-owned enterprises -- the two key remaining tasksin China's economic reforms, and I'm sure Nick will touch on in aminute.

But in Beijing as elsewhere, the President will alsomeet with new generations of leaders. Those beginning to rise toresponsible levels in both Beijing and the provinces are in theirforties and fifties. Compared to their predecessors, they have muchhigher levels of formal education, sometimes in the West, often inthe United States. They're also more flexible and pragmatic in theiroutlook. And they will need all of those qualities if they are tosuccessfully confront the enormous problems facing their country.

At Peking University the President will meet with aneven younger and still different generation of Chinese, in their lateteens and early twenties. This is the generation that more than anyother, enjoys American popular culture, dotes on the Chicago Bulls,and is eager for access to the Internet. And yet, like its elders,it remains understandably proud to be Chinese, can be highlynationalistic, and is often suspicious of American intentions towardsChina.

From Beijing the President moves on to Shanghai, China'scommercial capital since it was forcibly opened to trade by the Westin the mid-nineteenth century. Here he'll have the opportunity tosee evidence of socio-economic change in urban China, the emergenceof new classes of entrepreneurs and managers, some of whom own theirown businesses and of middle class consumers, some of whom now owntheir own homes.

Here, as in Beijing, the President will see that Chinesesociety is far freer than at any other time since 1949. And yet theability of Chinese citizens to practice religion freely or to pursuetheir interest towards independent political organization remainshighly restricted. In China one constantly sees the contrast betweenthe liberalization of social and economic life on the one hand, andthe remaining restrictions on pluralism in political affairs on theother.

The President's fourth stop will be Guilin, the site ofsome of the world's most spectacular scenery, which has served asinspiration to countless Chinese landscape artists and photographersfrom all around the world over the centuries. You will see, in fact,that the landscapes that you thought were fantasies in Chineselandscape art are in fact reality, when you see the environment ofthe Li River in Guilin.

But I understand the President will also be introducedat this stop to China's enormous environmental problems: thepolitical of air, water, and land. These problems, particularly airpolitical, have potentially dire consequences for both China and therest of the world. Polluted air is already becoming one of the mostsignificant causes of death in China. It is producing acid rain andgray haze in other parts of northeast Asia. And if unchecked, itwill contribute to global warming. Managing the contradiction betweeneconomic development and environmental protection will be one of themost important dilemmas for Chinese leaders in the decades ahead.

And finally the President will visit Hong Kong, theformer British colony that, as a result, is the most cosmopolitancity in China, and that for the last 20 years has been the keyeconomic link between China and the rest of the world. Thus far,Hong Kong's return to Chinese sovereignty has gone far more smoothlythan many people expected. Its free economic institutions and itslegal order remain intact, and it has just conducted its firstdemocratic election under Chinese sovereignty.

The issue, of course, is whether these political andeconomic institutions will continue to flourish, or whether they willgradually wither, and perhaps even more important, whether these sameinstitutions will be restricted to Hong Kong, or whether they willbecome a model for the rest of China.

The President's visit does not, and cannot, touch on allthe issues in today's China. But it will introduce him, and throughhis eyes the rest of us, to the problems of rural development,economic reform, generational change, political transition, andenvironmental protection in that country.

The President will see a China that is vastly differentthan the country which President Nixon saw in 1972, different fromthe country that President Reagan visited in 1984, and different evenfrom the China that President Bush saw in 1989. If through thisvisit we all can acquire a better understanding of China's dynamismand complexity, that alone I think will be a significant contributionto U.S.-China relations.

DR. LARDY: I'm delighted to have a chance to be hereand talk with you about some of the economic issues that loom largeas the President prepares to leave and will continue, I think, to bewith us for some time. I'll start with China and the WTO. We hadsome news from Ambassador Barshefsky over the weekend about progress,or more specifically, lack of progress, on that issue. Then I wantto turn and talk briefly about China's role in the Asian financialcontagion and the implications of that. And then finally I'll closewith a brief set of remarks on problems in bilateral economicrelations between China and the United States.

Let me start, though, with the WTO issue. The WTO, ofcourse, is the one major international organization -- economicorganization that the Chinese do not participate in. They have beennegotiating for accession since 1986. And I think during this periodwe have made a substantial amount of progress. The Chinese havereduced their tariffs fairly dramatically. These were as high as 43percent as recently as 1994; they're now down to about 17 percent.They have also largely eliminated a whole series of non-tariffbarriers that protected their markets, particularly licensingrequirements for imports and also quotas on imports. So there hasbeen a great deal of opening up of that market over time.

On the other hand, they have been very reluctant to openup their services sector, especially in distribution and in financialservices, banking in particular. And they still have a number ofother obstacles to imports, particularly statutory inspectionrequirements and certain other features of their trade system.

So I think the assessment that was being made thisweekend was that we're probably not going to see dramatic progress onthe accession process during the President's trip, although we'llhave to wait for the details to see exactly what happens.

Let me say what I think are the fundamental programshere, the underlying problems, and the context for looking at this.The first is -- the first problem that our negotiators have, quitefrankly, is that the United States has almost no carrots to offer inthis accession negotiation. The Chinese already have permanent MFNfrom every other country in the world except the United States.These negotiations will not necessarily give China permanent MFN inthis market, at least not immediately. So China is already gainingmost of the benefits from participating in the international system,and it is -- we have few carrots to offer in that regard in terms ofgetting them to further open up their markets.

I think the second problem is more recent, and that is,in the wake of the Asian financial crisis, China has become even morecautious on opening up its financial markets to full internationalcompetition. In particular, they're very reluctant to offerso-called national treatment for foreign banks operating in China,and they are very reluctant to give us a concrete timetable towardsmoving towards capital account convertibility.

I think, quite frankly, they have read the lessons ofthe Asian financial crisis correctly; they would be unwise to open upat this point. But the world community, the international community,including the United States, has very high expectations in terms ofan accelerated -- an almost immediate -- opening up of their marketsin the area of financial services. I don't think they are going todo it.

So I think probably for those two reasons, China'saccession is a ways off despite the progress that they have made overtime.

What is the risk to us if they don't come into the WorldTrade Organization? Well, I think, quite frankly, the risk is notenormous, but at this present time -- that is, over the last two orthree years, as China has emerged as one of the top ten tradingcountries in the world -- this is the only period, only years, in thepost-World War II period when one of the top ten trading countrieshas remained outside of the major international trade organization,the General Agreement on Tariffs and Trade, and its successororganization, the World Trade Organization.

So they are not a participant. That means two things:they are not fully bound by the rules, there is no timetable forgetting them to be bound by the rules; and, secondly, they don't havethe opportunity to participate in the formulation of the rules. AndI think particularly as we move into 1999 with new multilateral tradenegotiations on the horizon, that it is very important that we haveall the large players in the international system participating inthe system, not observing it from the outside. So there are somerisks to the world trading system if such a large player remainsoutside of the system.

What is the solution? I think the solution, quitefrankly, is to offer phase-ins that are consistent with China'sannounced plans -- Harry has mentioned these -- for commercializingits banking system, reforming its money-losing state-ownedenterprises. Zhu Rongji has announced a very aggressive program todo this in roughly three years. I think in critical areas theyshould be given long enough time phase-ins so that they will feelcomfortable signing on to all of the provisions of the internationaltrading system.

In other words, the issue is not really whether or notthey are going to be complying with all the WTO principles. Theyclearly must comply with them. But the issue is the length of timeover which they should come into compliance once they have actuallyacceded. I don't think the phrase that is so commonly used aboutcommercially viable terms for their participation is really verymeaningful. Of course they have to participate ultimately oncommercially viable terms. It's unlikely, however, that they aregoing to come into the organization if they have to participate onall of those terms on day one.

Let me turn secondly to China and the Asian financialcontagion. I think, to begin with, it is fairly obvious that Chinahas side-stepped some of the most obvious -- or the worst aspects ofthe contagion that we have seen over almost the last year now. Theyhave pledged to maintain the value of their currency; however, Iwould quickly add that this is largely in their own interest and,quite frankly, the price that they have paid for doing this, at leastto date, is fairly modest. They have not borne a high price formaintaining the value of their currency.

I think looking at last week's events, a number ofpeople speculated that one of the reasons the Treasury began tointervene in currency markets was the pressure China was placing --that China was putting the international community on notice thatthey were about to devalue if there wasn't some correction in thevalue of the yen. That is not the way I read it. I think ourintervention in those markets, at least as I see it, was really abilateral matter between Japan and the United States.

China, however, was and is very interested in Japan'seconomic future. I think as the depths of the crisis have becomeclear and the prospects are that it will take not just a year or twoto recover but maybe three to five years, I think the Chinese arelooking out and recognizing that the cost to them of maintaining astable currency over time will be much higher if Japanese recovery isdelayed. So they were signalling their basically similar view of theUnited States that Japanese performance is very important forrecovery from the crisis for the region as a whole. They were notsignalling, I believe, an intention to devalue any time in the nearterm. They are under no pressure at all. They still have a verylarge trade surplus. Although there are some difficulties on thecapital account side, they are not yet to the point where they arebeing forced to seriously consider devaluation.

So the Chinese comments were looking out six monthsahead, nine months ahead, two or three quarters, thinking, gee, ifJapan continues to soften, this could really get ugly for us and makeit much more difficult for us to sustain the kind of economic growthwe need for continuing our own domestic reform program andmaintaining the value of our currency.

Although they have, shall we say, dodged the biggestbullet so far, I do think there are some significant vulnerabilities.As Harry has already indicated, they are on the eve of -- and theyreally already have begun to implement one of the more far-reachingreform programs that they have undertaken over the last 20 years. AsHarry said, none of these transformations that he outlined are reallycomplete, and they are really trying to move very aggressively andcomplete a very large part of the agenda on the economic side overthe next three years. But, of course, they have discovered now thatthey are doing this in a much less favorable international andregional environment than they would have had even a year ago.

Let me just point out a couple of vulnerabilities thatthey have that I think have not been significantly or adequatelyappreciated. The first is that they already have significantlydiminished access to international capital. The currency is stable,yes. Their economy is still growing, yes. And in these respects, ofcourse, they differ from several other countries in the region,indeed almost all the other countries in the region. But theiraccess to capital is diminishing significantly. Foreign directinvestment in China has already started to fall. We don't know howfar it will fall, but it has started to fall significantly andundoubtedly will continue to fall throughout the second half of thisyear.

Other dimensions of accessing international capital arealso much less favorable. Last year, for example, they sold about$7.5 billion in equities on international markets in New York, HongKong, and in their own small dollar denominated B share market inShanghai and Shenyang. In the first half of 1998, they have onlysold a few hundred million dollars. In other words, their ability tosell in international markets has been very, very substantiallyharmed. Their stock prices have fallen almost as badly as some ofthe other most affected countries in the region. And so the termsunder which they can go to the market in 1998 are very much lessfavorable than they were only a year ago. So their ability toattract international capital through equity markets is verysubstantially impaired compared to a year ago.

The interest rate premium that they pay to sell theirdebt on international -- debt as opposed to the equity -- has alsogone up. Indeed, it has almost doubled and the Chinese governmenthas postponed -- a couple of months ago postponed a sovereign bondoffering that would have been on the market back in the March/Apriltimeframe. So the ability to sell debt has slipped, or at least theprice they would have to pay has gone up very significantly.

A second set of variables I would point to in terms oftheir vulnerabilities going forward, these are similarities that theyhave with Korea, Thailand, and Indonesia. They have a bank-dominatedfinancial system, the same kind of financial system that failed inseveral other countries in the region. They have a weak centralbank, which is critical also in places like Korea and Thailand.Their banking regulation and supervision is inadequate; that is, theregulation and supervision of their commercial banking system by thecentral bank is inadequate.

They have had a tremendous buildup of excess lending.The growth of lending in China is, in many ways, similar to thatwhich has occurred elsewhere in the region, and you can see it in thebuildup of asset bubbles when you go to Shanghai. Particularly ifyou go to Pu Dong you will see probably the world's biggest propertybubble in the making, with 70 percent of the space already vacant andthe completion of new buildings over the next year or two, based onwhat's already half completed, will put on the market roughly threetimes more space per year than they have absorbed on average in thelast two or three years. So the vacancy rates are 70 percent andgoing higher.

You see it also in a lot of manufacturing firms andindustries where there is a tremendous amount of excess capacitybecause firms have over-invested. They have built to get marketshare without adequate consideration for the rate of return on theinvestments that they have been undertaking. Again, that sounds verysimilar to Korea and Indonesia as well.

The consequence of this, again, as seen in China as itwas in the other countries in the region, a huge buildup ofnonperforming loans in the financial system, significant institutionsare failing, including today the People's Bank announced the veryfirst bank that has failed in China. A number of trust andinvestment companies have failed; some small credit unions havefailed. But today they announced the first significant -- the firstbank failure, the failure of the Hainan Development Bank, which wasthe site of rampant property development and other lendingirregularities that has gotten them into deep trouble. Sodepositors' funds are generally at risk in the Chinese financialsystem, as they are in other countries in the region.

So they face enormous challenges in continuing tomaintain the stability of their exchange rate, to contribute to therecovery from the Asian financial crisis. Certainly China'slong-term economic growth is very important in that respect.

Let me turn finally to the bilateral trade balancebetween China and the United States. This has been in the news,again, recently. I'll just make a couple of brief points. First ofall, the deficit is significantly overstated by the CommerceDepartment. It is something on the order of $36 billion, not $50billion. The reason is American firms sell about $6 billion in goodsto Hong Kong that then are immediately re-exported to China, and theCommerce Department doesn't want to count those as exports to China.They count them as exports to Hong Kong. The figures also overstateour imports. So we actually sell a great deal more to China than theofficial numbers suggest.

But more importantly than the size of any particulardeficit number -- I would say the deficit numbers really aremeaningless in a world with very highly mobile international capital.And one of the things that characterizes China and makes it differentfrom other countries in the region is its tremendous openness tointernational investment. China has attracted just in the last fiveor six years, when the numbers have gotten huge, much, much more --China has attracted more investment per year over the last three orfour years than Japan has attracted in the whole post-war period,cumulatively.

Japan has just remained fundamentally closed to foreigninvestment. China has been very, very open. So what we have seen isthe migration of labor-intensive manufacturing to China and, as aresult, we are buying large quantities of goods from China that weused to buy from Hong Kong and Taiwan.

But the job losses are not in the US. The job lossesare elsewhere in Asia, for the most part Hong Kong and Taiwan, tosome extent Korea. Consumers are gaining in the US from theavailability of much lower-priced products. US workers are gainingas well since our exports to China are generally in high-wageindustries and our exports to China have actually tripled since 1990,making China the fastest growing of our top ten export markets. Ihave a little chart on this if you are interested in seeing itafterwards. But it is really rather impressive how far we have comein terms of making China a very large market and, as I said, thefastest growing of our export markets since 1990, with growth ofexports of almost 20 percent per year.

So there are some problems in terms of reaching a finalagreement on China's accession to the World Trade Organization, but Idon't think it's fair to characterize that market as being closed.US firms have been doing very well there, particularly in the 1990s.

I'll stop there. Thank you.

Q Do you think that President Clinton should bemeeting with the dissidents when he's in China? Apparently, he hasno specific plan to do so. Is that a mistake?

DR. HARDING: I'm not sure it's appropriate for me to,in this place, give my recommendations on US-China policy.

Q I'm not asking you to recommend. I'm asking youropinion.

DR. HARDING: Well, they're awfully close to the samething. Let me make a few comments that perhaps put the issue inperspective. Number one, there are a lot of agents for change inChina, in addition to dissidents both at home and abroad, and it'simportant for us to understand the variety of people and, for thatmatter, institutions, both inside and outside the Chinese governmentand the Chinese Communist Party, both at home and abroad, that areforces for change in China.

Number two, I think one has to make a very carefulanalysis of how dissidents are viewed inside China, as compared tohow they may be viewed here in the United States or abroad. We haveto understand that some Chinese, including people outside thegovernment and the party, may not have the same admiration for someof the dissidents that we do here.

And, thirdly, one has to ask the question --

Q That's not a surprise. This happens everywhere.

DR. HARDING: Well, the third point that I would make isone that Sandy Berger made also, and that is a more strategicquestion: Do you think that meetings with dissidents or attemptedmeetings with dissidents will actually have a positive effect on thegeneral situation in China? We recall that the last time thishappened, when President Bush invited Fang Lizhi to his returnbanquet in Beijing, the result was that Mr. Fang was prevented fromattending the banquet. It certainly did no good for him, did notpromote positive change in China, did not promote US-China relations.So there are some tactical issues involved.

Q It made Americans look good.

DR. HARDING: That is an issue which we would have tostudy more carefully inside China. So it's a very complicated issue.I certainly think, simply as a general statement, there are many ways

in which we can make it absolutely clear that we are (a) in favor ofprogressive political change in China and (b) worried about thestatus of political dissidents in China than meeting with them ortheir families. And one has to make some very careful calculationsabout how best to promote that objective.

DR. LARDY: I would just add, anybody who has got a patanswer on this is probably being quite superficial. I think it's avery complicated question, as Harry has indicated, and I think thething one has to weigh very carefully is the risks to theindividuals, the Chinese individuals themselves. I certainlywouldn't recommend quickly that any American leader rush to meet withChinese dissidents.

Q Well, that shows a very tyrannical situation, ifthey would meet with an American president and then they -- that theywould be oppressed.

DR. HARDING: China is a complicated place and no onehas said it is not an authoritarian system.

Should we handle these questions ourselves?


Q On the Asian financial crisis, the Chinese havemade it increasingly clear, particularly last week, that they werelooking for direct US intervention which, ultimately, the US providedin the currency markets. Are you expecting during this that we aregoing to hear any pressure on the United States to take a moreproactive role in the financial crisis that goes beyond operatingthrough the IMF, but a more direct role, either in the currencymarkets or in direct support for other countries that are hurt or anylarger diplomatic role?

DR. LARDY: I'm not expecting the Chinese to mount ofseries of demands in that area; in fact, the Chinese have been verysupportive of the programs that the International Monetary Fund hasput in effect for three of the countries in the region. They havecontributed their own money to the Thai bailout crisis. And there iscertainly closer consultation on these issues.

But I don't think -- again, I would not share yourpremise that the Chinese were looking necessarily for intervention inthe currency markets last week. I think they were basicallyforecasting that the challenge they faced was going to escalatedramatically if the Japanese economy continued to shrink over thenext few quarters. I don't think that they were necessarilysignaling for intervention in the markets. And I think their viewgoing forward is that these countries have to work out the hugeproblems they have in terms of both foreign indebtedness and domesticindebtedness.

Q Mr. Lardy, both the President and the TreasurySecretary have spoken appreciatively of China's maintaining the valueof its currency. In simplistic terms, why is that so important tothe United States and why, when the Treasury Secretary won't speak atall about the value of the dollar, he is willing to speak publiclyabout another country's currency?

DR. LARDY: Well, I do think it's very important. Ithink stability in the region, in terms of currency values, now isquite important. And if China were to devalue significantly, itcertainly could set off another downward leg of the crisis. It couldknock the props out from under the Hong Kong dollar. I'm not sayingit would, but it could.

And, in turn, one would expect to see, even if the HongKong dollar peg was maintained, one would expect other currencies inthe region to come under enormous new pressure. They, in turn, mightdevalue. And you would set off another -- you could set off anothercycle of the crisis.

So I think that they are looking for stability and Ithink that's perfectly appropriate.

Q But what if that stability is at unrealisticvalues? What if it doesn't reflect what the market would value thosecurrencies at?

DR. LARDY: Well, China is in a little bit differentsituation, as I indicated. They don't have capital accountconvertibility so speculators who think maybe it's not quite at theright point can't really do very much about it, at least in the shortrun -- and I emphasize the short run. China has had, I would say, afairly successful policy of adjusting its exchange rate. Theydepreciated the value of the renminbi about 75 percent in real termsbetween 1978 and 1994, a very controlled -- they started out with ahighly overvalued currency; by 1994 they had brought it down to alevel that was probably very close to equilibrium in terms of tradetransactions.

One can argue today about whether or not it'sovervalued, undervalued, but we're not talking about a currencythat's wildly misvalued.

Q A technical question and a substantive question.You called it Peking University.

DR. HARDING: The last time that I looked at theirletterhead, the official English name of the university is PekingUniversity. Its address is Peking University, Beijing, China.(Laughter.)

Q So I can explain that and my editor will understandit. (Laughter.)

Zhu Rongji seems to be the economic reformer. You sayJiang Zemin seems to have taken over the reins of government. Whatis the Jiang Zemin doctrine? What does Jiang bring to the tableaside from the fact that he's in charge? What's going to be hissignature policy besides having Zhu do the reforms?

DR. HARDING: I think that's a very good question,because I don't think there is an answer to it quite yet. I thinkthat at this point, Jiang Zemin has been willing (a) to make it veryclear that he wants to see these final stages of economic reformcontinued and completed, and that he's willing to put one of thetoughest guys in China in charge of that process. You could say thatthat promptly passes the mantle to someone else, but I think thatJiang Zemin has to get credit for that as well.

Beyond that, I think that he would say, or the peoplearound him would say, that trying to stabilize U.S.-China relationsand trying to build towards the so-called constructive strategicpartnership is something else that Jiang Zemin would like to be partof his legacy. And that's another second part of his platform orprogram.

But that still leaves the question that many Chinesewould ask about what about political structure, what about politicalreform? It's clear that Jiang is presiding over some steps towardsgreater emphasis on the rule of law. The continued progress towardsvillage elections, the indication that they may be moved now up onelevel to the township in China hints that they may be moved into thebasic area -- basic level in the cities.

But he really still does need to put his mark on thatmost sensitive issue, which is what does he see as the evolution ofChina's political system. He will be cautious in this, given thefact that two of his predecessors, namely Zhao Ziyang and Hu Yaobang,fell from power when they attempted to answer that question. But Ithink that at some point he will have to try to make his mark on thepolitical side as well.

Q I'd be interested in your assessment of China'spolitical order, and particularly you said President Jiang is gainingin power right now --

DR. HARDING: In stature.

Q Gaining in stature. Okay, I beg your pardon. Ifhe's gaining, at whose expense is he gaining? What is his powerbase? What is his fundamental power base? Where does Prime MinisterZhu fit into the political structure, and what is his power base? DR. HARDING: I think increasingly one's so-called powerbase in China comes from the fact that they are elected by politicalinstitutions -- admittedly, communist party institutions -- that arebecoming more stable and predictable. So we don't write off the factthat Jiang Zemin was reselected by the Chinese Communist Party bothto head its organization and to head the state apparatus.

I think that beyond this his power base is reflected inthe fact that he is a sort of moderate figure. He is not seen assomeone who is in favor of dramatic political change, but he clearlyis also in favor of quite dramatic economic reform and perhaps moregradual and incremental political change. That means that heoccupies the middle of the Chinese political spectrum, which is inmany societies the best place to be.

When I said he was gaining in stature, I meant mainlyrelative to the vacuum created by the death -- the weakening and thenthe death of Deng Xiaoping, who was clearly China's paramount leader.And secondly, I was referring to the fact that some observers did seeJiang as a rather ineffectual compromise figure when he first waspromoted after the Tiananmen crisis of 1989. I think that he hasshown himself to be a skilled politician, and that's why he wasreselected. I don't see that this comes at anybody else's expense.It's more filling a vacuum that was created by Deng's death.

As far as Zhu Rongji is concerned, he is a popularfigure in some quarters in China because of his determination toundertake economic reform, and a very feared figure in others forexactly the same reason. He is not popular in the Chinesebureaucracy because he has said he is going to cut out 50 percent ofcivil service positions. He's not popular among Chinese stateindustry because he is going to force them to compete and todownsize. He's not popular among the workers who are going to belaid off in this process. So that his continued political survivaldepends on his ability to make these reforms work and to make thecase that the benefits of these painful reforms outweigh the cost.

DR. LARDY: Let me just make a comment on the Zhu Rongjithing. It is true, we've always thought that Zhu was opposed, say,by those people from regions that have heavy concentrations of stateindustry that were going to be badly impacted by the reform, andcertain other constituencies. He stepped on a lot of toes, shall wesay, when he was running the Central Bank from the middle of 1994 on.

On the other hand, when you get to the People's Congressthis spring when they had to vote for him, 98 percent voted in favor.They could have abstained. They could have voted no. The NationalPeople's Congress is not quite the rubber-stamp institution that itwas a decade ago. There have been lots of no votes on appointments.Which suggests that even though he doesn't have the easilyidentifiable power bases that some other leaders have, that maybethere is more of a consensus for pushing ahead on his tough reformagenda than one might have guessed earlier.

Q Are there any challenges on the horizon to Jiang orto Zhu, or is there a consensus at this point that those two menshould --

DR. HARDING: I think that the challenges increasinglyare not within the leadership but between, in effect, the leadershipand the entire society and the economic system. And so thechallenges are the enormous dilemma that I identified earlier: Howdo you restructure state-owned enterprises without creating enormoussocial and political unrest when you throw millions of people out ofwork? How can you afford to put into place a social safety net thatcan moderate the threat of unemployment? How can you cope with theinsolvent banking system that Nick Lardy has just described? How doyou deal with the environmental problems that China faces -- and onand on and on.

I think that it is that increasingly that is the problemin China, that I increasingly see the main contradictions not asbetween moderates and conservatives or liberals and conservativeswithin the leadership compound in Zhongnanhai. That may have been auseful way of looking at things in the Maoist era and even well intothe Deng Xiaoping era. Increasingly, though, I see a reasonablyunified central leadership that is struggling with enormouslydaunting problems. I would not wish their assignment on any closefriend. It is a huge task.

Q There has been a lot of criticism here on PresidentClinton being welcomed in Tiananmen Square. How do you see that?

DR. HARDING: Well, as I said in my opening remarks,Tiananmen Square has a lot of symbolism, both to Chinese andAmericans. It is not a place where only one event occurred; it is aplace where many events occurred, some extremely positive and someextremely tragic. So that this is a site that has lots of historicresonances, lots of meanings, and not just one.

I would have to say that a Chinese who was quoted by, Ibelieve, Steve Musson in the piece that he did on this issue in TheWashington Post rang true to me. It basically said that if PresidentClinton is going to come to China, he should really expect and acceptthe kind of welcoming ceremony that we traditionally give to visitingheads of state, at least in the last decade and more. Once he hasaccepted that framework, then he can say anything he wants and wehope -- many Chinese hope he will speak out on human rights. So thatthat comment resonated pretty well with me. That's how I understandChinese to think about it, too.

Q For those of us who were last in China whenPresident Bush was there, what are the biggest differences we aregoing to see?

DR. HARDING: I think that some of the biggest changesare the following. First of all, it is an even more dynamic societyeconomically. The growth of Beijing as a city, the growth ofShanghai has been truly impressive, although as Nick points out, muchof it, especially in Shanghai and especially in the so-called easternpart of Shanghai may be taking on the worrisome signs of a bubble.

Secondly, what I notice is the emergence of this newyoungest generation of Chinese. Again, Steve Musson -- I hate to begiving an advert for The Washington Post here, but he has been --manypeople writing from China have written some very fine stories inrecent weeks. Steve had this very interesting series on the culturalrevolution generation. My only concern about that series was (a)that it could have been written two, three, four years ago and (b)that there is yet another generation that is emerging, people who arenow in their 20s, perhaps their early 30s, who are quite different intheir outlooks: the so-called Generation X-ers of China, perhaps alittle bit less motivated by high issues of public policy, moreconcerned about making money, getting ahead, being successful, butmuch more exposed to the West, either directly or indirectly, thaneven the people in their 40s and early 50s.

In terms of political change, I sense a very differentstrategy, which may disappoint some people. I'll describe it asobjectively as I can. The pre-1989 strategy of political reformersin China, the Zhao Ziyangs and the Hu Yaobangs, was to make bigchanges in a sense from the top down, to redefine the role of theChinese Communist Party, to redefine its relationship with thegovernment in very grand, sweeping terms.

Since 1989, political reform, to the extent that it'sgoing on, is working from the bottom up, much more quietly in theareas that I mentioned -- rule of law, village elections, a moretechnocratic bureaucracy.

And even bigger than that is the trend that some Chinesecall the trend of moving towards a small state and a big society. Aseconomic reform continues, the government in China and the ChineseCommunist Party simply have fewer and fewer responsibilities. Theydo less; society and individuals do more and more. And that is avery different strategy and style of political change.

So in all these areas -- new generations, new wealth,new economic reforms and a different approach to political reform --Ithink it is a very different place than it was nine years ago.

Q Can I ask a question for Mr. Lardy? On the subjectof the economic reform that is taking place and the pending layoffsin the state industries, certainly one of their last -- that wasjust, you know, a dream, a glimmer, for some reformers. Is therereally an expectation that there are going to be such wholesalelayoffs that society is going to be turned upside down?

DR. LARDY: Well, I would begin by saying there alreadyhave been wholesale layoffs in many places. Whether or not societyis ultimately going to be turned upside down, we'll have to wait andsee. But I think one should not underestimate the progress that hasalready been made in recent months -- really, some of it began morethan a year ago. But the acceleration of layoffs is very dramatic,particularly in places like the northeast. Unfortunately, you won'tbe going there, but that is where it's more visible. I mean,combined with striking changes in the skyline and tremendous increasein traffic jams in most cities, which you'll see right away.

You will also see people begging and obviously homeless-- or what appear to be homeless people, maybe migrant workers whohave run out of money or whatever -- are quite visible, even inBeijing if you look around. And you wouldn't have seen that, or youcertainly would have seen very, very little of it, ten years ago.This is a much more marketized economy where, you know, lifetimeemployment is going out the window in many places and there is a lotof signs of labor mobility -- unemployment and so forth. So thoseare some very dramatic changes.

But I do think the changes in terms of cutting back onsome of the less well performing state enterprises are well underway.There is a long way to go. You know, maybe 20 million more peopleare going to have change jobs. You've got to think of it as changingjobs. They are leaving the state-owned enterprises. Hopefully, theywill find new jobs in service sectors and other industries,particularly if the banking system is able to redirect their lendingtowards new kinds of economic activity. I think that is the bigchallenge.

And this economy still has going for it a very highsavings rate, lots of resources. If they can improve the allocationof these resources, there is no reason they can't grow at least asfast as they have in the past, although getting to the new regime,getting to the new era, will obviously entail a significant amount oftransitional unemployment.

Q How many would you say have been thrown out of workso far due to the reforms?

DR. LARDY: Well, this is one of the areas where, quitefrankly, even the Chinese don't have good data and different agenciesthat try to collect these data have different criteria forclassifying people as unemployed. And the fact of the matter is mostof the people are in this intermediate status of being furloughedwhere they get, you know, a few dollars a week and get to maintaintheir housing. If their enterprise is very finally profitable, theymay retain access to their medical care and medical insurance and soforth. If it's not, they won't.

So these numbers -- you know, one hears numbers but thebasis under which they are compiled is not clear. It is well over 10million now. We are talking about an urban -- basically an urbanwork force, in the state sector, of about 110 million people. Thereare obviously some non-state people employed in urban areas as well,but if you are talking about 10 million to 20 million alreadyunemployed, you are talking about upwards -- you know, somethingapproaching 20 percent of the most important universe, that is,people that are working for state-owned companies.

Q On the question of Taiwan, what is the level ofChinese angst on that right now? How much do you expect they aregoing to want to dwell on it in the conversations with PresidentClinton? And are the repercussions of the '96 crisis pretty muchpast now?

DR. HARDING: The repercussions are not past because Ithink this was the most important single factor that caused bothgovernments to become aware of the potential dangers of confrontationand to work towards a more stable and cooperative relationship. Soin that way the lesson continues and, in fact, I hope it willcontinue.

In terms of how much angst they have and how much theywill dwell on it, I think that their level of angst is somewhat downthan it was before, as American officials have tried to reassure themthat our agenda is not to try to promote independence, not to try toprevent unification, but rather to promote a peaceful future forTaiwan. And as we have very subtly tried to encourage Taiwan to be alittle more flexible about the terms under which it returns to across-straits dialogue with its counterparts in the mainland. Sotheir level of angst is, I think, down, well below where it was inthe period of 1995-96 and maybe early -- well, early '97 anyway,although it can actually -- it can be easily reactivated at any time.It's neuralgic for the Chinese.

As far as what they will press for, I don't know. It'ssilly for me to speculate in too much detail about what is going tohappen in a very few days. I can tell you what Chinese policyanalysts that I have talked to have been pressing for at varioustimes in the past several months -- everything from a moratorium onUS arms sales to a pledge that we won't provide theater missiledefense technology to a statement that we positively favorreunification to reassurances that Taiwan is not within the scope ofthe US-Japan Mutual Security Treaty and so on and so forth. I thinkthat it is unlikely, extremely unlikely, that they will get very faron that wish list, if at all, and therefore they may not even press.

The big issue for them is always the question of generalintentions: Does the United States promote unification -- sorry,promote independence? Would it support reunification? As long asthey are reassured about long-term American intentions, that we'renot defining our interest as fundamentally opposed to theirs, I thinkthe smaller issues are easier to handle.

Q How about the question of Tibet -- early last weekin Washington and now they are pressing for more --

DR. LARDY: The President already mentioned the Tibetissue in his speech to the National Geographic Society last week.Again, I'm not here -- and though it's tempting in this setting -- tobe a spokesman for the US government. I'll simply give you myunderstanding of some of the outlines, that the United States has notchallenged the exercise of Chinese sovereignty over Tibet, but all ofus have very deep concerns about the status of human rights in Tibet,realizing that while in some ways the issues are the same as in allother parts of China, there are particular problems that arise inplaces like Tibet or, for that matter, Shenyang or, for that matter,Inner Mongolia, where there are ethnic minorities and you have aquestion of majority/minority ethnic relations on top ofstate/society relations.

So I think that the President said that, as many othersbelieve, that it would be wise to see a restoration of dialoguebetween the Dalai Lama and the Chinese. This is a person in mypersonal judgment with whom the Chinese would be well advised to opena dialogue.

Q How important is it that this summit be moresubstantive than symbolic in considering the differences on such keyissues as human rights? Can we expect this to be anything butsymbolic?

DR. HARDING: I would hope it would be both, and I thinksymbols are very important. They certainly are to the Chinese. AndI think that overall rhetoric, overall symbols, that give a sense of,again, the long-term principles that guide a relationship are offundamental importance to the Chinese. We, I think, tend to befocusing on immediate deliverables -- what progress will be made onissues X, Y, and Z.

One way of putting this, as a Chinese friend, acolleague in China, has put it is that both sides realize that thechallenge is to build trust and to promote a more cooperativerelationship. That's what we want to try to do. No guarantees thatwe'll succeed, but both governments seem to be wanting to do this.The thing is that we go about this from our different culturalperspectives in different ways. Americans tend to think that youbuild trust by accumulating progress on concrete issues, and out ofthat comes trust. The Chinese think that you build trust byestablishing and agreeing on basic principles to guide yourrelationship, and out of that comes the progress on concrete issues.That's a dilemma -- easily answered, however: you have to makeprogress on both fronts simultaneously.

So the symbolism of the summit is important if itreassures the Chinese that we want a cooperative relationship. Theevents surrounding the meetings across the negotiating table or inthe Great Hall of the People are important if they give the Presidentand you and the American people a better understanding of China.Substantive progress on major issues is also important if the policyof comprehensive engagement is to maintain political support in theUnited States.

So I'm hoping that a couple of weeks from now we'll lookback at this summit and be able to see things that were achieved onall of these dimensions, because they're all significant.

Q If I could return to the welcoming ceremony for amoment. The China adviser to a previous administration was quotedrecently as saying that until about a decade ago, the traditionalwelcoming ceremony for foreign visitors was not held at the GreatHall of the People --

DR. HARDING: Correct.

Q -- that it was held at the airport usually, andthat the Chinese changed the site after the Tiananmen Square events.They changed it to the Great Hall of the People to force foreignleaders to confront that --

DR. HARDING: I don't believe that that is true. Iconfess, if I'd had more time -- I did anticipate the question,that's the good news. The bad news, I didn't have time to check onthe facts.

My recollection is that they changed the site before theTiananmen crisis, as was evidenced by the fact that the issue ofwhere Gorbachev would be received came up. They could not have it atTiananmen Square, as they had planned, but rather at the airport.

My sense is -- it's something that Nick has alreadyreferred to -- it is, I believe, as prosaic as simply how muchleaders' time could be spent fighting the traffic to go to and fromBeijing Airport, to Capital Airport, to meet leaders. And theydecided to make a decision -- and I believe it was in the mid-1980s,I can't tell you when -- that they would simply move the welcomingceremonies downtown to spare the leaders these time-consuming tripsto and from the airport.

Now, it is true that they have had welcoming ceremonieselsewhere in the past. It is also clear that by insisting on havingthe welcoming ceremony in Tiananmen Square, that they make it lesslikely that we will be able, as a nation, to put Tiananmen behind us.Look at how much time and energy we are spending debating this issue.Many Chinese have said they wanted this summit to put TiananmenSquare behind us in U.S.-China relations. And yet the very site oftheir own welcoming ceremony works counter to that objective, if thatis indeed what they wanted to do.

Q There were some discussions earlier with regard to-- in the overall U.S.-China relationship, to try and get the Chineseto adhere to the MTCR in exchange to increase space cooperationsimilar to what we've done with Russia. Now, obviously because ofthe alleged Loral incident, the alleged transfer of technology toChina, and the rather inflamed atmosphere on Capitol Hill as a resultof that, the space cooperation has really gone on the back burner. Iwas wondering if there is still an attempt to try and come back tothese issues, which seem to be ultimately of significance in aU.S.-China relationship in the long term on this trip.

DR. HARDING: Well, if you're asking me about what'sgoing to happen on this trip and whether attempts will be made to dothis or that, you're asking the wrong person. I don't know. I thinkthat obviously the issue is not dead. It is a very high priority forus to get Chinese compliance with -- full compliance with the MissileTechnology Control Regime.

Let me simply make a broader point about thedifficulties that we face. We should not be too romantic orsentimental, although that's often the American tendency in dealingwith China, about this concept of a constructive, strategicpartnership. It's a concept that I happen to endorse, but we have tohave a very hard-headed view that what the Chinese mean by this is arelationship that involves lots of hard bargaining if cooperation isto be achieved.

What the political climate in Washington risks doing ismaking it more difficult for the President to engage in this kind ofbargaining, or at least makes it more difficult when he goes to thebargaining table, to carry positive incentives as well as negativeones.

I'm not commenting on the details of this specific deal,but rather simply to say that we can see the problem here, that ifthe President -- any President -- finds it more difficult to putforward a quid pro quo solution to a problem because of enormouspolitical opposition at home, we may find it more difficult to buildtowards this relationship that we're trying to build with China.

Q The fact that the President of the United Stateswill spend nine days in one country, that is a very good opportunityto educate the American audience. But at the same time it sends somesignals to surrounding countries, like Japan and Russia. What willbe the strategic implication of this visit?

DR. HARDING: Doesn't somebody want to ask abouteconomics? (Laughter.)

I understand the concerns in Japan about the issue thatyou have raised. All I would say is that a President cannot goeverywhere on every trip. I think that Presidents and Secretaries ofState, Ministers of Foreign Affairs, are going to have to do a lot oftraveling in today's world, meeting with different counterparts,

sometimes in groups, sometimes one on one, sometimes larger groups,sometimes smaller groups.

So I personally would not overstate the importance ofthis particular visit to U.S.-Japan relations. As I understand,there are already going to be other ways for the President to meetwith his counterpart, Prime Minister Hashimoto, in the near future.So I would not see this as anything --

Q Like what?

DR. HARDING: I believe that he's coming here. LateJuly.

So I think that at this particular time, I think it isappropriate for the President to spend a long time in China. It ishis first visit to the mainland of China. It's the firstpresidential trip since 1989. I think a longer visit, and a visitsolely to China, is appropriate this time.

On other occasions, once we get the relationship morestabilized, I'm sure the President -- future Presidents will bemaking other stops on their way to and from China. I would not readtoo much into this particular decision.

DR. LARDY: I guess I wouldn't accept the premise of thequestion. I don't think it's a zero sum game. If U.S.-Chinarelationships are improved, I think that redounds to the region as a

whole, and Japan in particular. So the premise of your questionseemed to indicate it was a zero sum game situation. I don't thinkthat's the case.

Q Question for Nick Lardy. You said it's not inChina's interest to devalue its currency right now, but their exportsare down, their growth is slowing. Why shouldn't they devalue it?

DR. LARDY: Well, a couple of reasons. First of all--some technical and some more major. Let me start with onetechnical one. About three-quarters, two-thirds to three-quarters ofwhat they export is with imported components. If they devalue, thegain they get in terms of export competitiveness is very, very modestbecause the value-added share is only about 20 percent. In otherwords, if you devalued, you'd pay more for the things that you'reassembling in China and about two-thirds to three-quarters of alltheir exports are made from imported components and assemblies. Sothe actual gains to devaluation to them are fairly small.

Secondly, those gains would probably be erased bydeclines in other currencies in the region. They cannot with anyconfidence undertake a devaluation and think that that is going to bethe last move.

And, thirdly, there are some major implications fortheir own domestic system. The Chinese leadership is increasinglyconvinced that a devaluation would be seen domestically as weaknessthat might precipitate a run on Chinese banks that could createproblems for stability in their own domestic banking system. Thefact that they're thinking this, quite frankly, is quite interestingbecause it reflects really how open the economy is, the large amountof foreign goods available for purchase by domestic residents and theextent to which Chinese people are beginning to think in terms ofpurchasing power over goods, not just domestically butinternationally.

DR. HARDING: And there would be a political cost interms of China's relations with the rest of the region since theyhave pledged to hold the line.

Pretrip China Briefings

Briefing by Harding and Lardy

Press Briefing by McCurry

Briefing by Berger, Rubin, and Sperling

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