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MAY 14, 1998

I appreciate the opportunity to appear before the Subcommittee on Telecommunications, Trade and Consumer Protection of the Committee on Commerce of the House of Representatives to present the views of the Semiconductor Industry Association (SIA) on China trade policy, especially as it relates to the accession of China to the World Trade Organization (WTO).

Before discussing the SIA's position on this important subject, I would like to take a minute to give some background on the U.S. semiconductor industry.

The U.S. Semiconductor Industry
Semiconductors are an increasingly pervasive aspect of everyday life, enabling the creation of the information superhighway and the functioning of everything from automobiles to modern defense systems. A recently released economic study found that the semiconductor industry is now America's largest manufacturing industry in terms of value-added -- contributing 20 percent more to the U.S. economy than the next leading industry. The average wage in the semiconductor industry is approximately $55,000, nearly twice the average of private industry overall. Furthermore, semiconductor price declines drive computer price declines. According to the Economic Report of the President, without the faster than average recent rate of decline of computer prices, overall inflation would have risen steadily since early 1994.

U.S. semiconductor makers employ about 260,000 people nationwide, and the presence of the industry is widespread ? 35 states have direct semiconductor industry employment. Semiconductor products are the enabling technology behind the U.S. electronics industry, which provides employment for 4.2 million Americans, in all 50 states.

U.S. semiconductor producers are highly committed to maintaining their lead in both semiconductor manufacturing and technology. The U.S. semiconductor industry devotes on average 20 percent of its revenues to capital spending and another 11 percent to research and development ? among the highest of any U.S. industry.

While investing heavily in the industry's future competitiveness and technological capabilities, SIA members also have actively sought open markets around the world. Because the semiconductor industry is so global in nature ? roughly half of the U.S. industry's revenues are derived from overseas sales ? the SIA has been dedicated since its inception to promoting free trade and opening world markets.

For example, the U.S. industry has been in the forefront of efforts to eliminate tariffs on semiconductors and related products worldwide. At SIA's urging, the United States, Japan and Canada eliminated their semiconductor tariffs in the mid-1980s. Earlier this year, another 39 countries agreed to eliminate their semiconductor tariffs through the proposed Information Technology Agreement (ITA), and last October, at the Washington summit meeting between President Clinton and President Jiang Zemin, China also agreed to join the ITA.

Given China's potential to become the largest single market for semiconductors in the world within a few decades, the SIA believes it is essential that the United States ensure that China accede to the WTO on a commercially sound basis.

Semiconductors in China
U.S. semiconductor firms are making substantial commitments to expand their market presence in the People's Republic of China. At the same time, China is seeking to foster its own electronics industry, with a particular emphasis on microelectronics, and is rapidly moving to integrate its economy more fully into the world trading system. As part of this process, the Chinese Government and its electronics industry are inviting closer contacts with the U.S. semiconductor industry, and significant opportunities and challenges have become evident.

While statistical data on Chinese semiconductor demand and output are limited, the market currently is estimated to be over $8 billion and it is growing at a rapid rate. Since 1985, the average growth rate in semiconductor demand in China has been about 24 percent per year. A number of observers believe that in light of China's growing domestic demand for electronics products, China will become the world's third largest semiconductor market by 2002 and the second largest market by 2010.

Presently local production can only supply about 20 percent of China's semiconductor needs, and these represent primarily low-end devices used in consumer electronics products like refrigerators, washing machines, radios, and televisions. Virtually all sophisticated semiconductors needed by Chinese electronics firms must be imported, a pattern that will not change significantly over the short run. This continuing shortfall creates a major commercial opportunity for U.S. producers.

At the same time, the Chinese Government, through what was until recently known as the Ministry of Electronics Industry ? now the Ministry of Information Industry ? is undertaking a significant effort to develop a competitive domestic Chinese semiconductor industry. While most semiconductor technology in China is currently at the 1-2 micron level, the Chinese Government is undertaking a number of projects designed to obtain cutting edge manufacturing technology at the 0.35-0.50 micron level, which would allow the Chinese industry to compete with the U.S. industry and other key world semiconductor producers.

The focus of this Chinese Government plan to develop its own industry is an effort to persuade foreign firms to invest in China and share their technology with Chinese firms through joint ventures and other partnership arrangements. In return, suggestions are made that increased market access may be made available to those firms willing to transfer technology. Reform of such practices must be at the heart of any agreement to admit China to the WTO.

The Information Technology Agreement
SIA commends the announcement last October by China that it would join the ITA as soon as possible and thereby eliminate its tariffs on semiconductors, semiconductor manufacturing equipment and related information technology products. This announcement was a critical step forward toward China's accession to the WTO on commercially viable terms. Unfortunately, there has been little progress toward implementation of this commitment, although SIA is hopeful that this issue can be resolved at the upcoming June 1998 Clinton-Jiang summit meeting in Beijing.

China currently imposes tariffs of 6-12 percent on semiconductors. Chinese tariffs tend to be higher on low-end semicon-ductors which China can make domesti-cally, and lower on complex devices which must be import-ed. Elimination of these tariffs will spur development of a competitive microelec-tronics industry in China, as it has in other nations. I am attaching a paper by two professors from the University of California on this subject. It will allow U.S. producers to sell advanced semiconductors to their Chinese customers at the lowest possible price, thereby both increasing U.S. exports and strengthening the developing Chinese electronics industry. Expeditious elimination of Chinese semiconductor tariffs through the ITA would also pave the way for the Chinese semiconductor industry to join the recently established World Semiconductor Council.

A related benefit of China signing onto the ITA will be the elimination of the very high tariffs -- up to 35 percent -- reimposed in 1996 by China on semiconductor manufacturing equipment and other capital equipment imported into China. At the end of December 1995, China's State Council announced that as part of a series of major reforms in its import tax regime it would eliminate previously existing tariff and value added tax (VAT) exemptions for imports of capital equipment for foreign enterprises, effective April 1, 1996. Until this change, foreign-owned companies in China and Sino-foreign joint ventures did not have to pay a VAT or duty on capital equipment imports. Currently these companies must pay an import duty plus a VAT of 17 percent assessed on the value of the equipment plus the customs duty. Given that tariffs on capital equipment continue to be relatively high, this combination had significantly raised the cost of capital imports into China.

Export Controls
The Semiconductor Industry Association continues to be concerned that there is not consistent treatment of export control requirements among China's major trading partners. The United States government has taken a very strict view of the Wassennaar Arrangement, and this has meant U.S. companies in many instances continue to face more stringent controls than do their foreign competitors, placing them at a disadvantage in the global market for semiconductors.

Policy Issues Relating to China's Accession to the WTO
The SIA supports China's bid to join the WTO, but only if that accession is accomplished on a commercially sound basis. In this regard, the SIA has a number of concerns with regard to trade and investment in China, including: (1) China's trade regime, especially its limitations on trading and distribution rights; (2) purchasing practices of China's state-invested enterprises; (3) investment restrictions in China, including those related to government pressure to transfer technology; (4) intellectual property protection; (5) Chinese targeting of particular sectors, including microelectronics in general and the semiconductor industry in particular; and (6) the U.S. ability to apply the non-market economy provisions of U.S. antidumping law to China. These particular concerns are described in detail below.

1. China's trade regime needs restructuring and does not currently conform to WTO requirements. China's foreign trade regime is a complex system with many anomalies which restrict the operations of U.S. firms in China:

Trading Rights. "Trading rights," (e.g., the ability to import and export from China), are limited to certain designated enterprises, including certain foreign-invested firms, which can trade products they manufacture in China. U.S. firms doing business in China that lack such rights must conduct their business through firms that hold such privileges. Moreover, a foreign company generally cannot directly sell or service end products, spare parts or components not made in China. These limitations are significant impediments to U.S. semiconductor firms' ability to access the Chinese market, and, if not eliminated, may undermine the benefit of other trade liberalization measures agreed to by China. SIA is encouraged by reports that China has committed in the WTO accession negotiations to provide trading rights to all Chinese firms within 3 years of its accession to the WTO, and urges that it move as quickly as possible to provide such trading rights to all firms, without discrimination on the basis of nationality.

Distribution Rights. Equally important as the right to import is the right to distribute goods within China. The current system forces U.S. producers to sell through Chinese distributors, adding at least an additional 10 percent in costs and adversely affecting service, inventory, and delivery. The inability to deal directly with end-users is a particular problem in the semiconductor industry, where the design and development of application specific chips requires extensive contact between semiconductor producers and the ultimate end-users of the chips. This critical issue currently is under negotiation in the context of China's commitments to provide market access and national treatment for foreign service providers.

Transparency. China's trade regime continues to lack transparency. Rules and procedures are not consistently published, and are subject to varying "interpretations" by individual officials. China should commit to publishing fully all relevant laws, regulations and decisions relating to trade and investment. SIA also believes that China should move to a system of advance notice and publication for comment of all laws and regulations affecting trade and investment, as well as to establish a system to obtain official interpretations of legislation once it is published (through judicial decisions that are published and authoritative administrative statements).

2. China's accession to the WTO must include a guarantee that state-invested enterprises will make purchases based on commercial considerations. Enterprises wholly or partially owned by the Chinese central, provincial or local governments (state-invested enterprises) continue to make up a significant portion of the Chinese economy. However, many of these enterprises are inefficient and burdened with costly social responsibilities unrelated to their core businesses. As a result, the state-sector of the Chinese economy is under increasing pressure. Half of China's state industrial enterprises incurred net losses last year, and profits of state-sector companies have fallen from 6 percent of GDP in the early 1980s to less than 1 percent in 1996.

Reform of the state sector is therefore at the top of the agenda for China's leaders. President Jiang Zemin has put forward a plan to "manage the large and let go the small," pursuant to which the state would retain shareholdings only in the largest 1,000 state-invested industrial firms, allowing approximately 117,000 smaller remaining firms to be merged, taken over by private investors, or dissolved.

This proposed reform plan has significant implications for the electronics sector, given its designation as one of four "pillar industries" ? industries the Chinese Government has targeted as essential to the nation's economic future. State-invested enterprises already control a significant share of the trade in electronics goods into and out of China. For example, the Chinese Government controls the China Electronics Corporation (CEC), which in turn owns or controls a significant share of China's electronics industry, including major consumers of semiconductors for consumer electronics and computer production. In addition, in the spring of 1997, the Chinese Government announced the formation of Project 909, a joint venture between Shanghai Hua Hong Microelectronics and Japan's NEC to produce state-of-the-art semiconductors in the Pudong New Area outside Shanghai. Hua Hong is a government-owned company, and its chairman is Hu Qili, the former Minister of Electronics Industry.

As a result of the continuing active government role in the electronics sector, there is a significant risk that as Chinese semiconductor production increases both in volume and quality, other state-invested enterprises will be encouraged by Chinese officials to purchase from domestic suppliers. Such discrimination could significantly burden or restrict U.S. semiconductor sales in China in the future.

These risks have been increased by recent reports that, as the Chinese Government moves out of many sectors, it will actually focus more attention on building up a select group of national champions in the electronics industry. Given the development of a potentially strong state-invested electronics sector in China, containing both semiconductor producers and consumers, it is essential that Chinese state-invested enterprises make purchases and sales only on the basis of commercial considerations. Unfortunately, current WTO rules do not effectively cover the purchasing decisions of state-invested commercial enterprises. For example, such enterprises are not covered by the GATT Government Procurement Code because the purchases of the enterprises are for the purpose of manufacturing commercial goods, not for government use.

Given the inadequacy of current WTO rules on this subject and the potential long-term significance of state-invested enterprises in the Chinese electronics sector, the SIA urges that China's protocol of accession to the WTO include affirmative obligations on the part of the Chinese Government to:

(1) ensure that its state-invested enterprises (including partially state-invested and recently privatized enterprises that were formerly state-invested) make purchases on the basis of commercial considerations; and

(2) afford the enterprises of other WTO Members adequate opportunity, in accordance with customary business practices in market economies, to compete for sales to state-invested enterprises.

SIA also believes that the protocol should require the Chinese Government to refrain from taking any measure, including administrative guidance, to influence or direct state-invested enterprises as to the quantity, value, or country of origin of goods purchased or sold, or otherwise impair the purchase or sale of goods. In addition, the WTO should review on a regular basis whether China's state-invested enterprises are in fact making purchases on the basis of commercial considerations. Where a WTO member country believes that the Chinese state-invested enterprises in a particular sector are acting in a manner inconsistent with the above-recommended obligations, it should be able to initiate consultations through the Working Party with China. This special Working Party should remain in place until the Working Party has determined that state-invested enterprises no longer control a significant portion of the Chinese economy or any significant sector.

3. Investment restrictions in China limit U.S. market opportunities and may force U.S. firms to transfer technology to Chinese firms. Wh-ile Chinese officials, especially at the local and provincial level, are quite interested in promoting foreign direct investment in China, a number of complex requirements exist for foreign-owned ventures. These rules place a number of restrictions on foreign investment:

Ownership Restrictions. 100 percent foreign ownership of manufacturing facilities is permitted in China, but it appears that, under an unpublished policy applicable to the electronics industry, 100 percent of such a facility's output must normally be exported. A 70/30 foreign majority-owned joint venture is generally required under the same policy to export 70 percent of its production, but there are no uniform rules; each arrangement is negotiated on a project-specific basis. For instance, in one case Chinese authorities reportedly removed the export requirement from a contract, provided the U.S. firm agreed instead to reinvest all profits earned from domestic sales.

Export Targets. Despite the absence of any explicit legal obligations to meet specific export percentages (except for purposes of obtaining preferential tax treatment or qualifying to establish a wholly foreign-owned enterprise) many U.S. companies have been pressed by the Chinese approval authorities to agree to export targets. While such rules are not always enforced, a company can legally be held accountable for non-compliance at a future date.

Local Content Requirements. There are localization requirements for parts and materials for products made in China which are not technically legal requirements, yet firms must file localization plans with their foreign investment application. The Chinese Government also audits foreign firms to determine local content. What constitutes local content can be subject to many definitions. For example, importation via a Chinese distributor can qualify a part as "local." Chinese sectoral industrial policies also contain local content requirements.

Pressure to Transfer Technology. Ownership restrictions, export targets and local content requirements may be imposed not only as strict legal obligations, but also as quid-pro-quos for decisions by government officials at both the national and sub-national level. Regardless of their form, these measures are often used as levers to obtain transfer of technology from foreign firms.

Existing WTO rules on Trade-Related Investment Measures (TRIMs) do not adequately discipline these measures. Yet these measures can have a real and significant competitive impact on U.S. electronics firms, as advanced technology is often the key to competitive success. To the extent that China can maintain such measures, U.S. exports in the electronics sector, such as semiconductors, may be restricted. Moreover, such investment restrictions have a negative effect on China, as they discourage the investment necessary to develop a local Chinese electronics industry on a commercially sound basis.

China's protocol of accession to the WTO should therefore include an explicit provision requiring China to refrain from taking any measure which requires a foreign enterprise to invest, enter into any form of joint venture arrangement with a domestic entity or to transfer any technology or intellectual property to a domestic entity, except in accordance with WTO rules. Such a provision must prohibit any measures that force technology transfer ? including any which are mandatory or enforceable under domestic law or under administrative rulings, or compliance with which is necessary to obtain any approval or advantage.

4. Intellectual property protection is inadequate. China has enacted patent, copy-right, and trademark laws, but their credibility requires strengthened enforcement. While there has been no piracy of semiconductor intellectual property to date, China's level of techno-logical development does not yet permit it to manufacture advanced U.S. products or misap-propriate U.S. chip designs. However, China's capabilities in the semiconductor sector are rapidly advancing. Therefore, the SIA remains very interested in issues relating to intellectual property protection in China and strongly supports the U.S. Trade Representative's efforts over the last few years to negotiate agreements with China to ensure increased enforcement of Chinese patent, copyright and trademark laws.

Of particular concern is the fact that compul-sory licensing remains authorized under Chinese patent law whenever "necessi-tated by the public interest." The WTO Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPs) prohibits the compulsory licensing of semiconduc-tor technolo-gy except in certain limited circum-stances. China should revise this law to bring it into conformity with the TRIPs Agreement as part of its WTO accession.

Accession to the WTO would also require China to enact specific legislation extending intellectual property protection to semicon-ductor layout designs (maskworks). In 1996, the SIA was told that a draft semiconductor layout design protection law had been prepared by the Ministry of Electronics Industry and was under review by the Chinese Patent Office. This is a positive development and every effort should be made to encourage the Chinese Government to continue to move forward on this front as expeditiously as possible. The SIA would like the opportunity to review and comment on the draft legislation prior to its enactment and would be willing to assist the U.S. and Chinese Governments in a cooperative effort designed to ensure that this legislation is fully consistent with all TRIPs obligations.

The SIA believes that China's protocol of accession to the WTO should commit China to abide by the obligations of the TRIPs Agreement as a developed country, without any transition period before the obligations are enforceable. This is in China's interest, as it will encourage the high technology foreign investment it seeks to promote the development of its economy.

In 1997, China reportedly did agree in the WTO accession negotiations to observe all obligations of the TRIPs Agreement upon its accession to the WTO. This was a welcome development for which the Chinese Government deserves credit. However, it is equally important that China begin taking concrete steps to bring its laws into full conformity with these TRIPs obligations and to ensure full and effective enforcement of these laws throughout China.

5. Targeting of the electronics sector may restrict U.S. market opportunities. The Chinese Government has designated four "pillar" industries for targeting as essential to the nation's economic future: automobiles, electronics, machinery and petroleum/petrochemicals. Within electronics, emphasis has been put on microelectronics.

There have been repeated reports that the Chinese Government had drafted an electronics industrial policy to promote development of its domestic industry. However, this policy plan has not been issued publicly. Obtaining information on the current status of the proposed electronics industrial policy remains an SIA priority objective.

While no details are currently available, earlier reports indicated that the electronics industrial policy could proscribe foreign majority ownership of semiconductor firms, establish export perfor- mance require-ments for Sino-foreign joint ventures, and provide the basis for eventual displace-ment of foreign semicon-ductors in China by domestically-made devices. Last year's establishment of Project 909, in which a foreign company (NEC of Japan) was granted a 28.6 percent share in a Sino-foreign joint venture in return for supplying the advanced technology for the venture suggests a continuing Chinese Government focus on development of a domestic semiconductor production capability. The Chinese Government has said that this joint venture is just the first step for Project 909, which ultimately envisages the establishment of four or five advanced semiconductor producers in China, with a dozen specialized plants around the country and around 20 design, development and research institutes. The production bases now appearing in China are centered in Beijing, Shanghai, Shenzhen and Wuxi.

Of particular concern to the U.S. semiconductor industry are policies to pressure foreign firms to transfer advanced technolo-gy. If such policies were adopted, either explicitly or as a matter of practice in connection with government approval of specific foreign investment projects, the SIA believes that they would restrict market opportunities for U.S. semiconductor firms. They would also prove counter-productive over the long run to China's interests because they would discourage the foreign invest-ment necessary to promote China's technologi-cal, economic and market development.

The 1992 U.S.-China Memorandum of Understanding (MOU) on Market Access provides that China will eliminate the use of import substitution policies and measures. A number of the elements outlined above are arguably inconsistent with this commit-ment. WTO rules also limit China's ability to establish local content require-ments. The SIA believes that any future policies governing China's economic development should adhere to the provisions of the 1992 MOU and WTO rules.

In this regard and consistent with the transparency obligations of the WTO, China should also commit to publish any internal policies or administrative guidance relating to its officially published industrial policies. The negotiation of China's accession to the WTO provides the appropriate forum for obtaining commitments by China to make the necessary reforms with respect to its electronics industry policy.

6. The United States must maintain the ability to apply the non-market economy provisions of U.S. antidumping law to Chinese exports. Chinese trade officials have cited the use of the U.S. antidumping law against Chinese exports as a "trade barrier" they wish to see removed in the WTO accession negotiations. In particular, Chinese officials are seeking to eliminate application of the non-market economy (NME) provisions of the U.S. antidumping law to Chinese exports, on the grounds that China is now a market economy.

U.S. antidumping law currently provides that, in the case of exports to the United States from a non-market economy such as China, the Department of Commerce is to determine the "normal value" of the product under investigation by valuing the non-market economy producer's factors of production in a surrogate market economy country which is a signifi-cant producer of comparable merchandise and which is at a level of economic development comparable to the non-market economy. These NME provisions are critical to ensuring a fair comparison of the normal value of goods produced in China with the export price of those goods in the United States. Without such provisions, the Department of Commerce would have to rely on the price charged for the goods in question in China, which, due to the substantial state control in many Chinese electronics firms, may bear little relationship to true market prices or the actual cost of production of semiconductors and other electronics components in China. Without the NME provisions of the antidumping law in effect, Chinese state-invested enterprises could in the future make significant below-cost sales of semiconductors in international trade, adversely affecting both the foreign trade and the domestic economy of the United States.

A provision therefore should be included in China's WTO protocol of accession to permit the United States to continue to apply the NME provisions of the antidumping law to China. The current draft protocol includes proposed text to this effect, but it has not yet been agreed upon.

China's semiconductor market represents a major opportunity for the U.S. industry, but there are significant risks and hurdles to be addressed as well, especially with regard to the rapidly growing Chinese market.

In microelectronics, China could become one of the world's leading producers, and, as such, it warrants continued monitoring to ensure that China's trade and investment regime does not discriminate against foreign producers. Ongoing bilateral and multilateral negotiations with China over the terms of its full integration into the world trading system can be utilized to address those aspects of the Chinese system which are problematic from the perspective of the U.S. semiconductor industry.

The U.S. Government is actively pursuing resolution of U.S. industry concerns in negotiations over China's accession to the WTO. SIA strongly supports the efforts of USTR and other U.S. Government agencies in this regard. Meanwhile, in meetings with SIA, officials of the Chinese Government and its electronics industry have demonstrated receptivity to many of the U.S. industry issues of concern outlined above. The SIA believes that the potential exits for a productive joint effort to address these issues in the context of China's accession to the WTO.

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