President Obama needs to push specific goals at his summit with Xi or risk coming away empty handed

Dean Cheng is a research fellow in Chinese political and security affairs and Derek Scissors is a senior research fellow in Asia economic policy in the Asian Studies Center at the Heritage Foundation

President Obama and the general secretary of the Chinese Communist Party, Xi Jinping, will meet starting Friday in California. The meeting has been characterized as a way for the two to establish a personal relationship and build trust. All would be well if it were Obama’s first year in office and Sino-American ties were on sound footing. But it is not and they are not.

It is long past time for the US to have a meaningful, tightly focused China policy. This meeting does not appear to support that goal. Rather, it is another in a series of ostensibly important but aimless steps on an increasingly rocky path.

The Obama administration should have specific goals for the summit and the Strategic and Economic Dialogue (S&ED) taking place one month later. First, the US should push for a timetable for a major reform to increase competition in the Chinese market, preferably in finance. Second, Obama should tackle cyber aggression by pursuing a detailed pledge in one area of the multi-dimensional problem. Third, the administration should take action that actually reduces tension at least one area of tension – for example, the Senkaku/Diaoyu islands dispute with Japan or the conflicting claims with several countries in the region in the South China Sea.

The best bet: financial reform

The problem in American economic policy toward China is priorities. There has been no concerted effort to set priorities straight since the People’s Republic joined the WTO in 2001. The US moves from one temporary irritant to the next, accumulating a pointless list of demands. The goal for the US should always be greater competition in the Chinese market, and for his second term, Obama should emphasize the financial sector.

As a large economy, China’s major issues are internal, including waste of physical assets, an aging labor force, wildly lax (total) credit and an innovation-killing expansion of the state sector. Domestic politics will determine whether market reform, populism or the status quo will prevail. Only if there is willingness to act on reform, not just talk, can the US play a role.

Aside from finance, there are few other areas in which the US pressure to reform would be effective. Land reform is vital but highly unlikely and too politically sensitive for US input. Also out of American reach is labor market integration through further changes in the hukou registration system that links social rights and benefits to the location of the household. Chinese monetary policy since the 2008 financial crisis has sown the seeds of stagnation, but, as with American fiscal and monetary policy, it will not be altered at foreign request. Obama and other American negotiators at the S&ED should not waste time on these matters.

It is possible that state-owned enterprises will be pruned and greater competition will be allowed from domestic private firms and multinationals. This would be welcome and, depending on the sectors involved, may help American companies and workers. A sweeping contraction of the Chinese state sector, however, would be determined internally, and effective privatization in a few industries would likely benefit the US only modestly.

The one exception, due to its central role, is finance. Banks and other institutions are intertwined with every aspect of the economy. Moreover, there are multiple options for market-oriented financial reform. For example, opening the capital account would allow money to leave freely and impose discipline on credit policy, discipline that Beijing increasingly recognizes as necessary. A narrower step would be opening the Chinese bond market to foreign capital. This would help establish a true interest rate system and offers huge potential benefits to China in terms of capital availability.

Happily, there is an obvious carrot the US can offer: meeting China’s terms for better investment access to the American market. Given that Chinese politics will determine any changes in economic policy, the best choice for the US is to push for market-oriented financial reform and request a timeline for those reforms.

While the US should make a purely economic proposal, cyber espionage melds economics and security. The administration has belatedly recognized the economic importance of cyber issues, but it may not yet have recognized how deep the problem is on the Chinese side. A full solution will not be possible for years. At this summit, the US can tie cyber issues to the main economic discussion by making clear that recipients of stolen intellectual property cannot invest in American assets and that further sanctions are likely unless Chinese espionage eases.

Cooling tensions in cyberspace and beyond

The issue of cyber security will almost certainly extend from the economic to the military and political. The recent report from the Defense Science Board (DSB), a civilian group appointed to advise the US Department of Defense, and the department’s annual report to Congress on Chinese military developments have both highlighted the security threat posed by Chinese cyber activities. American and Chinese officials recognize that cyber intrusions and aggression has the potential for escalation. What is less clear is whether China understands that, since cyber attacks can be “as serious as a nuclear bomb,” China’s persistent cyber aggression erodes not only their credibility but mutual stability.

The US should not attempt a grand solution to cyber attacks but rather determine if there are areas in which China is willing to curb its behavior, reflected in an actual reduction in incidences of Chinese cyber intrusions. In the meantime, the administration should determine the prerequisites necessary for retaliatory action against Chinese cyber aggression when it is perpetrated by the Chinese military.

Cyberspace is not the only point of mutual friction. Chinese assertiveness on its borders has antagonized a range of states, many of which are US allies. Most notable has been the Senkaku dispute, as Chinese and Japanese law-enforcement vessels and aircraft continue to confront each other around these islands. But China has also renewed its push in the South China Sea, not only dispatching a naval task force to the waters near Malaysia, but also deploying a frigate near Second Thomas Shoal, which is claimed by the Philippines.

This militarization of the South China Sea disputes, coupled with Beijing’s rejection of arbitration despite being a party to the Law of the Sea Treaty, raises the potential of an escalating crisis ultimately involving the US.

Unlike the economic sphere, it is less clear how the two sides can reach a modus vivendi in the security arena. This is exacerbated by the administration’s tendency to surrender potential bargaining chips for
little gain. Thus, China has been invited to the 2014 Rim of the Pacific multilateral exercises with no expectation of a quid pro quo from Beijing. Instead, the US should be making clear that further military-to-military contacts will be predicated upon a more conciliatory Chinese approach to its border disputes with US allies.

To accomplish these goals, the administration should additionally fill the vacant policy slots at the defense, state and treasury departments as quickly as possible – ideally in time for the S&ED. In policy, details are essential, and having the staff to work through them is critical.

The US needs to make specific progress on a focused set of goals. If the Obama-Xi meeting and the S&ED culminate with the usual 40-point communiqué of emptiness, it will be another missed opportunity. Perhaps opportunities can be endlessly missed, and bilateral relations will still muddle along. But the relationship is clearly more fragile than it was a decade ago. Progress in financial reform, cyber and territorial disputes is feasible and would put the relationship on much safer ground. 

Edited and republished with permission from The Heritage Foundation, a conservative think tank based in Washington, DC. For more information, visit www.heritage.org.