Henry Paulson: The path to double happiness

When President Barack Obama and Chinese President Xi Jinping meet this week in California for an unusually private set of conversations, national-security issues are sure to dominate. Make no mistake: Whether, and how deeply, the two countries cooperate on North Korea and Iran will be an important test of their relationship. Another top priority will be growing American concerns about cybersecurity, which, more than any issue, has the potential to damage trust and confidence in relations with China.

But because economic issues have anchored the Chinese-American relationship in recent decades, it is important that the two presidents seize this moment to reinvigorate their shared economic agenda. This is the first time since China's accession to the World Trade Organization in 2001 that the political and economic climates in both countries are ripe for establishing mutually beneficial economic agreements.

China has made strong economic progress over the past decade because of adaptations required by WTO membership. That process has benefited the U.S. and China significantly. Yet in recent years, reform in China has stalled. There is an urgent need for China to restart its reform process and continue to open its markets to competition.

Just as China's WTO accession furthered the cause of economic reform, so too can negotiating new economic agreements with the U.S. President Xi Jinping and the new leadership team recognize that reforms are essential for China's economic success. Meantime, President Obama is focused on restoring America's competitiveness, and he understands the importance of international trade and investment to accomplish that goal.

The case for launching significant economic negotiations this week is compelling. For starters, China and the U.S. have the world's largest economies and did a record-shattering $493 billion in two-way trade in 2011. U.S. exports to China have more than quintupled since China entered the WTO and have grown more quickly than imports. In fact, China is America's fastest-growing export market. When world-wide U.S. exports dropped almost 18% during the 2009 financial crisis, exports to China dropped only about 2.5%.

This demonstrates China's potential to become a demand driver for U.S. products over the long haul. It also demonstrates the degree to which our economies are intertwined.

This interdependence has touched the lives of ordinary Americans and Chinese: U.S. innovations have helped raise living standards across the world, including for hundreds of millions of Chinese. For its part, China has exported capital at a time when Washington has been a major borrower. More than $1 trillion in Chinese holdings of U.S. Treasury securities have helped finance U.S. deficit spending and keep interest rates low.

Given such extraordinary interdependence, economic tensions are too high. In China, export lobbies have fought for policies that favor their interests and limit foreign competition. Although the U.S. economy is much more open than China's, national security concerns and increasing Chinese cyberintrusions have led to rising levels of anti-China sentiment that have made Chinese investment here more difficult. Trade deficits persist. And many U.S. companies argue that Beijing is tilting the playing field to favor its own national champions.

Xi Jinping, now president of China, met with Barack Obama in the White House in 2012. Photo: Reuters

But the fundamental issue is that U.S.-China economic relations would be more secure if our economies were better balanced and on more sustainable, complementary trajectories.

Right now, they aren't. China saves too much, produces too much, sells too much to Americans and consumes too little. For its part, the U.S. saves too little, consumes too much and would like to produce and sell more to China. The challenge for both countries is to fashion an agenda that makes future economic success more secure.

Here's the good news: In addition to setting a positive tone, China's new leadership team is beginning to act in ways that have the potential to rebalance the country's economy. These leaders aim to replace a growth model that has relied too heavily on government investment and exports with a model focused on household consumption and competition. This won't be easy. But if they succeed, it will mean new markets and opportunities for U.S. companies. Clearly, it is in Washington's best interest to use bilateral negotiations to help Beijing make this transition.

Both countries have recently agreed to tackle two important issues as part of their Strategic and Economic Dialogue. One, on climate, offers an opportunity to make breakthroughs on this major threat to the global economy and ecosystem. The other, on cybersecurity, could forge common ground on a problem so fraught it could easily derail the U.S.-China relationship.

In addition to addressing these two key issues, promoting cross-border investment flows is also necessary. One vehicle for doing so, while advancing negotiations on market access and securing equal competitive conditions, is the Bilateral Investment Treaty, or BIT. Such a treaty would enhance investor protections for both sides.

If China is to achieve its new economic model, it must introduce competition into its economy. In financial services, for example, allowing foreign financial firms to compete equally will create more open and efficient capital markets and help transition China to a nation of investors, not just savers.

Beijing should also introduce more competition to help its own private sector. Anticompetitive practices hurt Chinese private firms nearly as much as foreign ones. For all their subsidies, benefits and preferential access to credit available only to state-owned enterprises, it is private firms that are the major source of Chinese job creation. Weaning state-owned companies off subsidies will benefit them by making them more competitive. It also would ensure market rules for the private, small and medium-size businesses that create most Chinese jobs, yet are largely excluded from state-backed loans and resource subsidies.

Ultimately, both countries need capital to flow more freely: Americans because they need job-creating capital flows, including direct investment from China, and the Chinese because Beijing wants to invest more in the U.S. China complains about a lack of clarity in the U.S. regulatory framework. The U.S. could help address that concern by enacting more transparent investment policies, which would lead to more Chinese investment in the U.S.

This is a rare moment of opportunity for both countries. We can continue to play defense, or we can play offense by using negotiations to make our economies more balanced. If we squander the moment, we will regret it.

Mr. Paulson, chairman of the Paulson Institute, served from 2006-09 as the 74th U.S. Treasury secretary. Previously, he was chairman and CEO of Goldman Sachs.

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