US-China SED Progress Slows With Political Transition,Reforms

By Chris Cermak and Drew Pierson

WASHINGTON (MNI) - U.S.-China watchers expect only incremental progress over economic sticking points between the two countries in the latest round of the Strategic & Economic Dialogue in Beijing this week, with much of the focus simply on holding the process together amid tensions over Chinese dissident Chen Guangcheng.

With political transitions underway in both countries, and the recent decline in China's current account surplus blunting one of the key U.S. priorities, both sides are likely focused on keeping momentum for more meaningful talks once the political dust settles next year.

Yet the still-pronounced economic imbalances within China mean the U.S. will take the opportunity to emphasize domestic reforms -- subsidies for state-owned companies and financial market liberalization -- along with the more "familiar territory" of intellectual property rights and continued appreciation of the Chinese currency, said Nicholas Lardy of the Peterson Institute for International Economics.

The case of Chen, a blind civil rights lawyer who escaped house arrest and entered the U.S. embassy last week, had the potential to derail the entire meeting, but Lardy said it seemed both sides were "bending over backwards" to keep the dialogue going. Chen left the U.S. embassy Wednesday, with China reportedly agreeing to relocate him to a safe environment, but demanding an apology from the U.S..

Still, "expectations for this particular version or iteration of the SED are pretty low," Lardy told reporters in a conference call Tuesday. Both sides "want to get over the political transitions" and are instead simply "trying to create some forward momentum that can be built on by the next administrations."

That means larger sticking points are unlikely to progress, such as long-running talks on a bilateral investment treaty and intellectual property rights, as well as China's priority of easing high-tech U.S. export controls, which requires congressional approval that is unlikely to come in an election year.

Yet there is some hope that another recent political development, the ouster of Communist party chief Bo Xilai, could help accelerate the kinds of political and economic reforms that the U.S. has been seeking.

Bo's absence at the least means one more spot for a reformist at the upcoming, once-a-decade transition of power between Chinese President Hu Jintao and his expected successor, Xi Jinping, said Barry Naughton, So Kwanlok Chair of Chinese International Affairs at the University of California, San Diego, at a Brookings Institution panel in Washington. Currency alignment meanwhile is expected to be lower on the radar screen for the first time in a while, given the unexpected decline in China's current account surplus in 2011 continuing this year.

China's current account surplus fell to 1.4% of GDP in the first quarter of this year, down further from 2.8% in 2011. Yet the International Monetary Fund expects the surplus to rise back above 4% in coming years and has voiced concern that the decline is driven more by investment, not by increased domestic consumption.

Naughton said China's rate of growth will slow in part because of tightening monetary policy and reduced consumer demand. Chen Zhiwu, professor of finance at the Yale School of Management, also on the Brookings panel Tuesday, said a drop-off in capital-intensive investments by the government could be a third factor impacting growth.

"The tendency is to prefer infrastructure and big projects because theyre very tangible," Chen said, but added the rate of growth will likely be reduced if the government moves away from such high-profile projects in coming years. U.S. officials, while welcoming China's moderate liberalization and moves to allow more currency appreciation -- including the central bank's recent decision to widen the trading band -- have continued to emphasize greater rebalancing as an economic priority in both countries' long-run interest.

"Our priorities in our economic relationship with China -- from its exchange rate to its treatment of intellectual property -- reflect changes that are fundamentally in China's interest and essential for sustainable economic growth," Treasury Secretary Timothy Geithner said last week.

Arvind Subramanian of the Peterson Institute told reporters that while "the situation has changed" recently, he expects a joint statement from both sides will still include a forward-looking note that "the pace of appreciation will be maintained going forward."

Geithner was due to arrive in Beijing Wednesday, with the dialogue expected to begin Thursday and a joint press conference planned Friday with U.S. Secretary of State Hillary Clinton and their Chinese counterparts for the talks, state councillor Dai Binggou and Vice-Premier Wang Qishan.

--Chris Cermak and Drew Pierson are Washington reporters with Need to Know News

** MNI Washington Bureau: 202-371-2121 **