Routing

Congress set a dangerous precedent when itinterfered with Hong Kong–based CNOOC, Ltd.’sbid for Unocal. Supporters of the interventionargued that CNOOC, a subsidiary of state-ownedChina National Offshore Oil Company, couldpose a threat to U.S. economic and national secu-rity. Yet Unocal was only a small player in the U.S.energy market and had no technology that mightpose a real threat to U.S. security. Nonetheless,congressional pressures prompted CNOOC towithdraw its $18.5 billion bid, paving the way forChevron to acquire Unocal for $17.7 billion.

The increasingly confrontational approachCongress is taking toward China is leading to “creep-ing protectionism,” often in the guise of protectingU.S. national security. Although it is proper to criti-cize China for its human rights violations and its lackof a transparent legal system, we should not ignorethe substantial progress China has made since itembarked on economic liberalization in 1978.

A policy of engagement—or what Hu Jintao,president of the People’s Republic of China, calls“peaceful development”—is a necessary conditionfor constructive U.S.-China relations. AlthoughChina’s competitiveness does pose a threat to cer-tain U.S. economic interests, it also benefitsAmerican consumers and exporters. Protectionismwould harm both the United States and China andwould increase the likelihood of conflict. Hardlin-ers would gain at the expense of more reasonablevoices.

To avert the risk of conflict, the United Statesneeds to treat China as a normal great power, notas an adversary; ensure that only those commer-cial transactions that genuinely threaten nation-al security are blocked; and recognize that byincreasing economic freedom we increase per-sonal freedom. Our economic security, as well asChina’s, will depend on sound free-market poli-cies, not on destructive protectionism.

U.S.-China Relations in the Wake of CNOOCby James A. Dorn

_____________________________________________________________________________________________________

James A. Dorn is a China specialist and vice president for academic affairs at the Cato Institute. He is also professorof economics at Towson University in Maryland and coeditor of China’s Future: Constructive Partner orEmerging Threat?

Executive Summary

No. 553 November 2, 2005

Introduction

In its 2005 Annual Report to Congress on theMilitary Power of the People’s Republic of China,the Pentagon described U.S.-China relationsas “cooperative, candid, and constructive.”The report stated, “The United States wel-comes the rise of a peaceful and prosperousChina” but warned that with growing wealththe PRC will be able to modernize its militaryand could pose a “credible threat” in EastAsia and beyond.1

One growing concern voiced both by thePentagon report and by Congress is that China’sdemand for direct ownership of oil and gas andother “strategic assets” will pose security risks,particularly if China acquires U.S. energy com-panies. In a congressional hearing on July 13,Frank Gaffney Jr., president of the Center forSecurity Policy, told the House Armed ServicesCommittee that the sale of Unocal Corp. toCNOOC, Ltd. (hereafter CNOOC), a HongKong–based subsidiary of China NationalOffshore Oil Company, “would have adverseeffects on the economic and national securityinterests of the United States.” He pointed to“the folly of abetting Communist China’s effortto acquire more of the world’s relatively finiteenergy resources” and warned of “the larger andominous Chinese strategic plan of which thispurchase is emblematic.”2

Such fears are evident in the flurry of anti-China resolutions and bills introduced bymembers of Congress around the time of theCNOOC-Unocal bid. On June 30 a nonbind-ing House resolution (H.R. 344) recommend-ing presidential review of the CNOOC dealpassed by a vote of 398 to 15. In a letter toPresident Bush, House Energy and CommerceCommittee chairman Joe Barton (R-TX)declared, “We urge you to protect Americannational security by ensuring that vital U.S.energy assets are never sold to the Chinese gov-ernment.”3

When the China hawks in Congressjoined forces with the protectionists, a strong(and dangerous) coalition was formed toeffectively end any chance that CNOOCwould be successful in its bid to acquire

Unocal. After Congress amended the EnergyPolicy Act of 2005 (H.R. 6) in late July—torequire a lengthy review of the proposedtakeover—CNOOC abandoned its $18.5 bil-lion bid for Unocal on August 2.

Although Congress used national securityarguments to justify the close scrutiny of theproposed CNOOC-Unocal deal, the relativelysmall size of Unocal convinced most expertsthat the security card was really just a ploy to tiltthe deal in favor of the other suitor—California-based Chevron. Indeed, Chevron is located inthe congressional district represented by thechairman of the House Committee onResources, Richard W. Pombo, the very personresponsible for amending H.R. 6 to require thatthe Department of Energy, along with theDepartments of Defense and Homeland Secur-ity, conduct a 120-day study on the economicand security implications of China’s growingdemand for energy. An important provision ofthat amendment was that the White Housecould not approve the CNOOC offer until 21days after the DOE study was completed. Byadding as much as 141 days to the takeoverprocess, Congress undermined CNOOC’sincentive to continue the bidding war withChevron and convinced Unocal’s board toaccept Chevron’s cash-and-stock offer valued at$17.7 billion.4

In scrapping its bid, CNOOC managementsaid that “unprecedented political opposi-tion” made it impossible to successfully com-pete with Chevron by “creating a level ofuncertainty that presents an unacceptable riskto our ability to secure this transaction.”5 Thatcomplaint reflected an earlier statement by theChinese foreign ministry: “We demand thatthe U.S. Congress correct its mistaken ways ofpoliticizing economic and trade issues, andstop interfering in the normal commercialexchanges.”6

Although Chevron is the clear winner, con-gressional interference in what should havebeen primarily a market transaction sets a dan-gerous precedent and could jeopardize U.S.-China relations. The firestorm on Capitol Hillsurrounding the CNOOC bid for Unocal ismerely one case in the rising anti-China trend.

2

When the China hawks in

Congress joinedforces with the

protectionists, astrong (and dangerous)

coalition wasformed.

Indeed, as Albert Keidel, a senior associate atthe Carnegie Endowment for InternationalPeace, writes, “Those who would build a GreatWall of America to fend off China’s influencecould end up jeopardizing everyone’s long-term peace and prosperity while doing little toimprove prospects for political change inChina.”7 By politicizing the takeover marketand weakening the private property rights ofUnocal’s shareholders, Congress violated thevery free-market principles it is supposed touphold.

The Politicization of CNOOC’s Unocal Bid

Congress is right to criticize China for itshuman rights violations, its failure to protectintellectual property rights, and its lack of agenuine rule of law. Nevertheless, in morethan two decades of economic reform, Chinahas made significant progress in reducingpoverty and opening to the outside world.Capitalists are now free to join the ChineseCommunist Party, people can own privateproperty, and the PRC Constitution has beenamended to better protect the private sector.Article 13 of the constitution now reads,“Citizens’ lawful private property is invio-lable.”8 In contrast, “under Mao, large publicnotices everywhere had urged people to ‘Strikehard against the slightest sign of private own-ership.’”9

China has a long way to go before it is afull-fledged market economy and a free soci-ety, but preventing China from entering U.S.markets, whether for capital or for goods andservices, will not ensure “peaceful develop-ment”—the professed goal of President HuJintao of the PRC.10 Washington’s interfer-ence with the CNOOC-Unocal deal mighthave been warranted if there had been a legit-imate threat to national security, but in thiscase that possibility seems remote. As energyeconomist Phillip Verleger said: “There’s nonational security issue here—zero. Unocaldoesn’t have technology that needs to be keptsecret.”11

What may concern Congress more thanthe so-called security threat, which was neverclearly defined in the case of CNOOC, is theidea that China may gain control of energysources, crowd out American buyers, and usethe “oil weapon” to undermine U.S. influ-ence in East Asia and elsewhere. The logic, asstated in House Resolution 344, is simple:

1. Oil and natural gas are “strategic assetscritical to national security and theNation’s economic prosperity.”

2. China is an authoritarian regime “strong-ly committed to national one-party ruleby the Communist Party” and ownsabout 70 percent of CNOOC’s stock.

3. Subsidized loans will be used to helpfinance the proposed takeover.

4. CNOOC may ship oil and natural gasdirectly to China rather than sell it inworld energy markets, which “wouldresult in the strategic assets of UnocalCorporation being preferentially allocat-ed to China by the Chinese government.”That “would weaken the ability of theUnited States to influence the oil and gassupplies of the Nation through compa-nies that must adhere to United Stateslaws.”

5. The acquisition “could provide accessto Unocal Corporation’s sensitive dual-use technologies that the United Stateswould otherwise restrict for export toChina.”

6. The CNOOC deal therefore threatens“to impair the national security,” and“the President should initiate immedi-ately a thorough review of the proposedacquisition, merger, or takeover.”12

In fact, the Congressional Research Servicereports that Unocal is an insignificant playerin the U.S. energy market, accounting for only0.8 percent of U.S. production of crude oil,condensate, and natural gas liquids. Unocal’sU.S. production of petroleum is a miniscule0.3 percent of U.S. consumption. The CRSreport also notes that “because oil is a fungiblecommodity in a world market, it can be

3

The firestorm onCapitol Hill surroundingCNOOC is merely one casein the rising anti-China trend.

argued that it matters little where oil suppliesoriginate.”13 CNOOC will pay the going worldprice for oil no matter where it is produced,and oil will flow to the highest bidders.

Moreover, if CNOOC acquired Unocaland directly shipped oil to China, instead ofbuying it on the open market, there would beno net change in the world price of oil—so theUnited States would not be “crowded out.”China would buy less oil on the market andthere would be more available for othercountries to purchase. Congress ignored thatobvious reality in H.R. 344.

Even so, CNOOC had agreed not to divertUnocal’s U.S. production of oil and gas toother markets. Rather, since most of Unocal’sproduction of oil and natural gas is locatedoverseas, particularly in Southeast Asia, itwould be logical for China to tap those moreproximate sources. Just as the United Statesis searching worldwide for new energysources, so is the PRC. If Congress preventsChinese firms from acquiring U.S.-basedcompanies such as Unocal, the Chinese willlook elsewhere—including friendly statessuch as Canada as well as rogue states such asSudan and Iran. If we want China to open itscapital markets, we should open ours.Limiting Chinese investments in the UnitedStates—when there are no obvious risks tonational security—could backfire if Beijingdecided to retaliate. Lee Raymond, chief exec-utive of Exxon Mobile Corp., which hasinvested heavily in China’s energy sector, saidthat the United States would make a “bigmistake” by blocking CNOOC’s bid. “Youhave to have free trade,” he said. “If you startto put inefficiencies in the system, all of useventually pay for that.”14

The United States should pay attention topossible security threats posed by foreignacquisitions of U.S. companies, but in theCNOOC-Unocal case such a threat lookedrather remote. True, Indonesia’s Bontang liq-uefied natural gas (LNG) refinery was expectedto buy 40 percent of its gas from Unocal overthe next decade and sell most of it as LNG toTaiwan, Korea, and Japan. Consequently, crit-ics such as the American Enterprise Institute’s

Thomas Donnelly and Melissa Wisner, writingin the Weekly Standard, argued that CNOOC’scontrol of Unocal’s Indonesian assets wouldhave increased China’s influence in East Asiaand allowed the PRC to exert even more lever-age over Taiwan, which depends heavily onLNG from Indonesia. In their view, China’senergy strategy is to increase its sway not onlyin Asia but worldwide, “with the effect (andalmost certainly the intent) of underminingthe United States.”15 However, it is also truethat China could blockade Taiwan at any timebut has not done so because it would be pro-hibitively costly to China’s development strate-gy. Instead, it is more likely that CNOOCwould honor long-term contracts and strive toincrease production.

China’s strong-arm tactics and threatsagainst Taiwan easily generate criticism andmake China “the piñata of American politics,”as AEI’s Kevin Hassett has noted. However, themore serious issue is that “such responses cre-ate a very big problem for free traders in theU.S.” and “demonstrate that protectionistshave a large group of influential new allies.”16

Protectionism in Disguise?

Currently, foreign companies are free toinvest in U.S. energy assets. British Petroleumand Royal Dutch Petroleum (Shell) have sizablestakes in the United States, and Venezuela’snational oil company, PDVSA, was allowed toacquire CITGO, which controls nearly 7 percentof U.S. refining capacity. Meanwhile, many U.S.energy companies have joint ventures inChina.17 Ultimately, energy security will dependon market-based pricing and free trade.18 Thoseare the policy issues that Congress should befocusing on, not on a bogus security threat froman acquisition that would give CNOOC controlover a small U.S. company that accounts foronly a tiny fraction of global oil production.

China, through joint ventures and produc-tion-sharing agreements, already has access tocurrent technologies for exploration for oil andgas and for production and refining.19 Unocal’sexpertise in deep-water drilling no doubt would

4

Limiting Chineseinvestments in

the UnitedStates—when

there are no obvious risks to

national security—could

backfire.

be of value to CNOOC, but selling that tech-nology is not equivalent to selling MIRV (mul-tiple independently targetable reentry vehicle)technology to China. At the House ArmedServices Committee hearings on the CNOOC-Unocal deal, Rep. Curt Weldon (R-PA) broughtup the issue of MIRV technology as if it weresomehow pertinent to the hearing. He accusedJerry Taylor, director of natural resource studiesat the Cato Institute, of minimizing the securi-ty threat of a CNOOC takeover of Unocal.Taylor replied: “Chinese acquisition of militarytechnology would be worrisome, but I’m notaware that Unocal has [that] technology, noram I aware that it has the technology you’ve dis-cussed. My understanding is that there is noth-ing Unocal has in the oil sector that isn’t avail-able through contractors, or private vendors, orwhatnot—that there’s nothing proprietarythere. If there were, I’d be happy if the UnitedStates government were to provide somerestrictions.”20

Indeed, there was no need for Congress toget involved in the security issue because that isthe job of the secretive Committee on ForeignInvestment in the United States, a 12-membermultiagency panel headed by the secretary ofthe treasury. CFIUS was created by the Exon-Florio amendment to the Omnibus Trade andCompetitiveness Act of 1988 to deny foreignacquisitions of U.S. companies if it can beshown that “other U.S. laws are inadequate orinappropriate to protect the national security”and that there is “‘credible evidence’ that theforeign investment will impair the nationalsecurity.” Once the committee decides to inves-tigate a case, it has 45 days to make a recom-mendation to the president, and the presidentmust act within 15 days. Although evidence isdifficult to obtain because of the secrecy sur-rounding CFIUS, it appears that, of the 1,560cases reviewed since 1988, only 25 were fullyinvestigated, and of those only 12 were sent tothe president, who can either accept or rejectthe committee’s recommendations. In only onecase was the challenged acquisition denied onnational security grounds. In 1990 PresidentGeorge W. H. Bush prohibited China NationalAero-Technology Import and Export Corpor-

ation, a state-owned enterprise, from acquiringMamco Manufacturing Company, an aero-space company with dual-use technology.21

Given the facts of the CNOOC-Unocal case,it is unlikely that it would have gone all the wayto the president, and if it had, it is highlyunlikely that he would have denied CNOOC’sbid for Unocal unless there were serious securi-ty concerns unearthed by CFIUS. A judicioususe of CFIUS is warranted. The committee’slack of transparency poses problems for acountry whose allegiance is to the rule of law.

Congress’s decision to amend the energybill to prolong the review process was the finalstraw that was intended to break the back ofthe CNOOC-Unocal deal. As Pombo admittedin an interview, “If we hadn’t put the amend-ment in the energy bill, they [CNOOC] mighthave succeeded.”22

Ironically, the energy bill itself purported to“ensure jobs for our future with secure, afford-able, and reliable energy.” And Pombo’s amend-ment may have had that effect—if only in hisdistrict. It was a political act grounded in nar-row self-serving economic concerns, not broad-er U.S. prosperity or security.

But Pombo was not alone. The anti-Chinahyperbole that was evident on Capitol Hillprior to the CNOOC pullout is exemplifiedby Rep. Tom Tancredo (R-CO), who stated,“By itself, this takeover may seem small, but afew more deals like this one and Americacould find itself held hostage not just to theenergy brokers in the Middle East but toChina as well.”23

The reality is that the bidding game forUnocal was primarily market driven andCongress should have let CNOOC fight itout with Chevron so that shareholders gotthe best price. Congressional critics over-looked the fact that most of Unocal’s over-seas production of oil and natural gas wasalready contractually committed and wouldnot be available for the Chinese market.Moreover, they ignored the obvious econom-ic reality that, regardless of who won the bid-ding battle for Unocal, the allocation of ener-gy supplies ultimately depends on globalcompetition and proximity to markets.24

5

Ultimately, energy securitywill depend onmarket-basedpricing and freetrade.

If China did try to restrict the supply of oilto the United States—that is, to use the so-called oil weapon—it would hurt China asmuch as the United States because China isnow a net oil importer and must pay marketprices. It might even cause greater harm inthe PRC because, as Taylor pointed out in histestimony before the House Armed ServicesCommittee, China’s energy usage is muchless efficient than that of the United States,and “the Chinese economy is less able to effi-ciently adjust to price shocks.” Hence, “thereis no reason to worry about the impact that amerger between CNOOC and Unocal mighthave on domestic energy prices or America’saccess to oil. Unocal would not provideChina with an ‘oil weapon.’”25

There is little doubt that CNOOC’s bidwould have prevailed if not for congressionalinterference. In June the spread betweenCNOOC’s bid and Chevron’s was nearly $2 bil-lion, and CNOOC was prepared to increase itsoffer price. However, after the intervention ofCongress and the amendment to the energy billthat increased transaction costs to CNOOC,the tables turned. Jason Putman, an energy ana-lyst with KeyCorp’s Victory Capital Manage-ment, which holds a large number of Unocalshares, estimated that the increase in risk due toCongress’s actions resulted in a $513 milliondecline in the value of CNOOC’s all-cash bid,which was enough to make the proposed dealuntenable.26 In a letter to Unocal’s board, PeterSchoenfeld of P. Schoenfeld Asset Manage-ment, which also controls a block of Unocalshares, reminded the board that it was their“duty to maximize value for stockholders.”27

Indeed it was. But Congress inserted itself in themiddle of the CNOOC-Unocal deal and, in sodoing, became an overseer rather than a protec-tor of shareholder rights.

Although CNOOC’s bid was to be partlyfinanced by the Chinese government, whichholds more than $711 billion in foreignexchange reserves, that would have been agift to Unocal shareholders—not a concernfor Congress or U.S. energy security.

Even without a legal prohibition on a deal,Congress can intimidate a foreign company

such as CNOOC by imposing considerablecosts on the takeover process and using thesecretive Committee on Foreign Investment tobreed uncertainty. That is not to say we shouldlet foreign companies have totally free accessto assets of all U.S. companies. In some cases,especially in the area of sensitive technologywith military applications, there may be legiti-mate risks. Going through a government vet-ting process would then be warranted.

Congress Should Promote Engagement,

Not ProtectionismThe CNOOC-Unocal deal must be consid-

ered within the broader context of U.S.-Chinaeconomic engagement. The rising U.S. tradedeficit with China, which will approach $200billion this year, has roused the ire ofCongress—even though U.S. consumers havesaved billions of dollars through expandedaccess to Chinese imports and American pro-ducers have gained from the growth of theChinese market (exports to China have dou-bled since 2000).

Many members of Congress and other peo-ple tend to think of trade with China as a zero-sum game: China wins, the United States loses.That mercantilist mindset naturally leads tothe perception that China’s growing wealth—wrongly called “economic power”—is a threatto U.S. economic and national security.Gaffney was explicit on that point, telling theArmed Services Committee, “I believe thePRC’s aim is inexorably to supplant the UnitedStates as the world’s premier economic powerand, if necessary, to defeat us militarily.”28

Likewise, Randall Schriver, a former top Chinaofficial at the State Department, told Reutersthat the United States and China could be on a“collision course” due to Beijing’s willingnessto seek out rogue states to ensure sufficientenergy supplies to meet its huge demand andto maintain high economic growth.29 Ofcourse, the United States may be pushingChina in that direction by effectively denying itaccess to U.S. companies like Unocal.

6

Congress inserteditself in the

middle of theCNOOC-Unocaldeal and became

an overseer ratherthan a protector

of shareholderrights.

There are many signs of growing hostilitytoward China, with the PRC often used as ascapegoat for U.S. domestic problems. Repre-sentative Tancredo has introduced legislation(H.R. 1450) calling for “additional tariffs” on“any nonmarket economy country until thePresident certifies to the Congress that thatcountry is a market economy.” He would thenearmark those tariff revenues for the “SocialSecurity trust funds.”30

Likewise, the passage by the House on July27 of the U.S. Trade Rights Enforcement Act(H.R. 3283) is a step backward for U.S.-Chinarelations. Although that act is unlikely tobecome law, it “authorizes the application ofthe U.S. countervailing duty [CVD] law to ex-ports from nonmarket economies such asChina.” Nonmarket economies are alreadysubject to anti-dumping law, which in mostcases unfairly penalizes China by using pricesin other developing countries such as India todetermine if China is selling at “below cost.”Penalties are then assigned. The arbitrary anddiscriminatory nature of this practice is wellknown.31 Using CVD law would simply in-crease protectionism in the global economy,not advance China’s march toward a true mar-ket economy.

Another prime example of protectionist leg-islation aimed directly at China is Congress’sthreat to impose punitive tariffs of 27.5 percenton Chinese exports to the United States ifBeijing does not revalue the yuan by thatamount. Action on the Schumer-Graham bill(S. 295) has been temporarily delayed becauseof the recent change in China’s exchange rateregime, in which China allowed the yuan toappreciate by 2.1 percent and moved to a man-aged float by pegging to a basket of currencies.Many members of Congress, however, still feelthat China is engaging in unfair trade practicesby undervaluing its currency. So we can expectSen. Charles Schumer (D-NY) and his col-league Sen. Lindsey Graham (R-SC), alongwith other members of Congress, to renewtheir efforts.

China’s new exchange rate regime is a farcry from the free-market system advocated byU.S. Treasury Secretary John Snow, but it is in

line with Premier Wen Jiabao’s goal of devel-oping “an exchange rate system that is moremarket-oriented and flexible.”32 Its successwill depend on whether China relaxes ex-change and capital controls and liberalizesinterest rates. Washington should be patientwith China. Only 13.5 percent of U.S. importsin 2004 came from China, so even a 20 percentappreciation of the yuan would reduce thetrade-weighted value of the dollar by less than3 percent. Slapping prohibitive tariffs on theChinese, on the other hand, would injureAmerican firms operating in China, harm U.S.consumers, slow economic growth, andendanger U.S.-China relations over the medi-um to long term.

Engagement versus Confrontation

The combination of animosity towardChina and ignorance about energy marketswitnessed on Capitol Hill poses a serious riskto the policy of engagement that has workedto advance China’s private sector and givenmillions of people the opportunity to exit thestate sector and escape poverty. Eventually,the growth of China’s middle class will createstill more pressure for political reform thatwill advance fundamental human rights.Indeed, that is already occurring, as evi-denced by the recent amendments to thePRC Constitution that give greater protec-tion to private property rights.33

Alarm over China’s economic and militaryrise is often justified by reference to China’spoor human rights record, but that record willnot be improved by denying the Chinese peo-ple the right to trade, which itself is an impor-tant human right.34 Countries that are leftoutside the global trading system, such asCuba and North Korea, have shown no inter-est in advancing human rights and have per-petuated poverty. Do we want that for China?

What China needs is less government andmore markets. And the surest way to achievethat result is to strengthen the policy ofengagement, not to threaten China with sanc-

7

Countries thatare left outsidethe global tradingsystem haveshown no interestin advancinghuman rights.

tions if it supplies Americans with cheap tex-tiles and apparel or to use dubious nationalsecurity arguments to deny China the right tobid for U.S.-owned energy companies. Deny-ing China access to our markets while requir-ing it to open its markets is hypocritical andwill only play into the hands of hardliners whoalready distrust the United States.

Yet politicians on both sides of the aisle inCongress see China as a major threat to U.S.jobs and view trade as a form of economicwarfare rather than a mutually beneficialarrangement that increases the wealth ofnations. They forget that, as Alan Greenspansaid before the Senate Finance Committee inJune,

In the decades ahead, it is in our interestand that of the global economy thatChina continue to progress towardbecoming a more market-based, produc-tive, and dynamic economy in whichindividual initiative, not governmentdecision making, is the fundamentalstrength behind economic activity. Forour part, it is essential that we not putthat outcome, or our future, at risk witha step back into protectionism.35

Even before joining the World TradeOrganization at the end of 2001, China hadmade substantial progress in moving toward amarket economy and liberalizing trade. Mostprices are now determined by demand andsupply rather than by central planning, and, asNicholas Lardy, a scholar at the Institute forInternational Economics, told a congressionalcommittee, “China is certainly one of the mostopen, perhaps the most open, of all emergingmarket economies.”36

Since 1978 China has dramatically trans-formed its economy and increased economicfreedom. Congress should see China’s pros-perity as a positive development, not a threatto U.S. security. In 1980 China’s economicfreedom score, based on the Fraser Institute’sEconomic Freedom of the World: 2005 AnnualReport, was 3.8 out of a possible 10; by 2003 ithad risen to 6.0.37 That score is still low in

comparison with Hong Kong’s, which was8.7 in 2003 (the latest data), but China ismoving in the right direction.

Although China is by no means a free soci-ety, the advancement of economic liberty, asan important component of U.S. foreign poli-cy, will help promote overall freedom. Theprocess may be painfully slow at times, butwhat is the alternative? Institutions and newways of thinking do not emerge overnight—orbecause Congress wills them to. Erik Gartzke,a political science professor at ColumbiaUniversity and a member of the SaltzmanInstitute of War and Peace Studies, writes,“Since prosperity is necessary for stabledemocracy and sufficient to produce peace,the best foreign policy is one that enhancesand extends capitalism.”38 If the United Statesis to maintain a “cooperative and construc-tive” relationship with China, the first order ofbusiness should be to adhere to a policy of eco-nomic engagement.

China is an emerging market economy, butthat does not mean it can dismantle its largestate-owned enterprises overnight. While out-right privatization has been slow, the party lead-ership has allowed the nonstate sector to growrapidly so that it now accounts for the bulk ofChina’s economy. That transformation of eco-nomic life—from a centrally planned economyto an emerging market economy—has given theChinese people new opportunities and hasexposed them to Western ideas and culture. Toshut off trade because China does not revalueits currency according to the dictates of the U.S.Congress would be foolish. Likewise, denying ajoint-stock company like CNOOC, which is list-ed on Hong Kong and New York stockexchanges, the opportunity to acquire a smallU.S. company like Unocal interferes with therights of U.S. shareholders and with the free-dom of international capital markets.

Of course, if CNOOC were a truly privatefirm, Congress would not have been so con-cerned. China’s challenge is to move morerapidly toward privatization and the rule oflaw. Future cross-border transactions willthen be less costly and more successful, andU.S.-China relations should improve.

8

Congress shouldsee China’s

prosperity as a positive

development, not a threat to

U.S. security.

President George W. Bush calls U.S.-Chinarelations “good” but “complex.”39 Lately theemphasis has been on “complex.” Yes, U.S.-China relations are “complex,” but they havealways been so. Allowing Congress to steerthose relations only adds to the uncertaintyand complexity. The United States needs a firmcommitment to engagement, and China needsto adhere to “peaceful development.” Little willbe gained by constantly treating China as athreat, on the basis of presumed intentions. Atthe same time, we must not underestimate thewillingness of hardliners in the ChineseCommunist Party—who have little regard forthe rule of law and want to retain their monop-oly on power—to revert to military means toachieve their ends, especially in the case ofTaiwan. Consequently, we need to be realisticand cautious, but not unreasonable.

The administration appears to be moving inthat direction. In a pathbreaking speech to theNational Committee on U.S.-China Relations inNew York on September 21, Deputy Secretary ofState Robert B. Zoellick avoided confrontationand instead called upon the PRC “to become aresponsible stakeholder in the international sys-tem.”40 At the same time, the United States mustrecognize that China is a rising normal powerand will pursue its own interests. As Liu Jianfei, ajournalist with the China Daily, recently wrote:“Currently the biggest obstacle in Sino-U.S. tiescomes from misgivings held by some Americanstowards China and their Cold War mentality. Ifsuch an outdated view is overcome, the twonations can build a strategic mutual trust andopen new co-operation in the future.”41

It is a grave mistake to use the nationalsecurity card to deny Chinese firms the rightto purchase natural resources in the openmarket when there is no credible security risk.Beijing will view such behavior as yet anotherattempt by the United States to widen itspower at the expense of China’s development,further increasing anti-American sentiment.

China’s thirst for oil and natural gas hasdriven world demand upward and increasedprices, and that trend is likely to continue.Over time, production and consumption willrespond to higher prices as producers search

for new supplies and consumers conserve andswitch to cheaper alternatives. If the U.S. gov-ernment interferes with the market process,future production will suffer, and U.S. energycompanies will find it more difficult to oper-ate in foreign countries.

Washington would be wise to heed theadvice of Prime Minister Lee Hsien Loong ofSingapore, who in his July 12 speech to theU.S.-ASEAN Business Council said, if theUnited States values its influence in Asia, itmust take “a considered, long-term approach,upholding its commitment to free markets,free trade, and international rules.” However,“if it yields to short-term political pressuresand turns protectionist, the damage to U.S.interests in Asia and its standing worldwidewill be long lasting.”42

Instead of centering foreign policy on hypo-thetical “intentions,” it would be more fruitfulto rely on observed actions and fulfilledpromises. In the case of CNOOC, there was noenergy security threat, nor was there any signif-icant risk to national security. Derek Butter, anenergy analyst with Wood Mackenzie inEdinburgh, argues that CNOOC’s bid forUnocal had “little to do with security of supplyfor China.” Instead, it had to do with theChinese wanting to create a company that “cancompete with the other international compa-nies, and has the skills in the future to negoti-ate its way into large projects.”43

People who would deny China access toU.S. markets or assets on the basis of “eco-nomic security” would do well to rememberwhat AEI director of economic policy studiesKevin Hassett has noted—namely, that “anyeconomic harm we do to China by impedingit will be as harmful to our own citizens as itis to the Chinese.” In his view, U.S. foreignpolicy should support, not oppose, econom-ic engagement with the PRC. The reasons arestraightforward: (1) “free trade is a powerfulforce for economic good”; (2) “our policiescan’t do enough economic damage to Chinato be politically meaningful”; and (3) “Chinais too small economically to corner the mar-ket in anything significant.”44

Sticking to our free-trade principles, rather

9

China’s challengeis to move morerapidly towardprivatization andthe rule of law.

than sacrificing them piecemeal to specialinterest groups, would be the best defense offreedom, peace, and prosperity. The UnitedStates and China are both net importers of oil;and both depend heavily on imports fromSaudi Arabia, which is neither a democraticregime nor one that respects human rights.China is not a centrally planned economy likethe former Soviet Union or North Korea. It isone of the most liberalized economies in thedeveloping world. The United States has moreto gain from a “cooperative and constructive”policy of engagement with the PRC than fromone based on the premise that China wants toand can dominate the world. Such an attitudeshows a lack of confidence in the institutionsthat have made America great—namely, limit-ed government, the rule of law, and freedom ofchoice in a market system.

Those liberal values should be practiced athome, and free trade with China is the best wayto transmit them abroad. As Montesquieuwrote in his classic treatise On The Spirit of theLaws in 1748: “Peace is the natural effect oftrade. Two nations who traffic with each otherbecome reciprocally dependent; for if one hasan interest in buying, the other has an interestin selling; and thus their union is founded ontheir mutual necessities.”45

Even if commercial engagement does notpreclude conflict, it clearly reduces the likeli-hood of conflict. China’s growing commercialrelations with Taiwan are a case in point.46 Withmassive investments in China, Taiwanese busi-ness owners and politicians have an incentive totake a cooperative rather than a confrontationalapproach in dealing with Beijing, and China hasan incentive to avoid conflict that could cause asignificant loss of trade and wealth. Stabilityrequires that China continue to grow, which, inturn, requires peaceful international trade andthe ability to attract foreign investment.

Peaceful Development

President Hu’s term “peaceful develop-ment,” as a way to describe China’s rise and asa strategy for dealing with the United States

and other nations, has merit. It is certainly abetter description of post-Maoist China thanmuch of the heated rhetoric heard on CapitolHill. China is less apt to cause trouble if it con-centrates on wealth creation and povertyreduction rather than global dominance—thegoal of the former Soviet Union.

Today, after more than 25 years of eco-nomic reform and liberalization, the Chinesepeople are far more prosperous than theywere during the reign of Mao Zedong. Itwould be a tragedy if that progress were jeop-ardized by a confrontational U.S. approachtoward China. U.S.-China relations ultimate-ly should rest on adherence to a rules-basedliberal trading order, which means that pure-ly commercial decisions should be marketdriven, not politicized.

As congressional reaction to the CNOOC-Unocal deal shows, however, the rising U.S. hos-tility toward China could lead to a train wreckunless calmer voices prevail. As Joseph Borich,former U.S. consul general in Shanghai andnow executive director of the Washington StateChina Relations Council, notes:

There is no question about the existenceof an influential group in and outsideof Congress (often called the “BlueTeam”) that views China as a threat tothe U.S. on the same order as the formerSoviet Union. They see trade and virtu-ally all other U.S. dealings with China aszero-sum, with no possibility for win-win relations with China. For the BlueTeam, CNOOC’s bid to acquire Unocalis not simply a business transaction; itrepresents a direct threat to vital U.S.security interests.47

If future U.S.-China relations are to improve,that zero-sum, mercantilist mentality must giveway to a more positive way of thinking abouteconomic relations and security. Chinese andAmerican companies should be left alone totrade, unless there is a legitimate threat tonational security.

We should not be blinded by the fact thatChina is a nominally communist country. There

10

The United Statesneeds a firm

commitment toengagement, and

China needs toadhere to “peaceful

development.”

are many reformers in the Chinese CommunistParty who seek further changes, and there aremany people outside the CCP who want a moreliberal regime. State ownership is no longerwidely admired in China, nor do most peopletake communist ideology seriously. ZhengBijian, head of the China Reform Forum and asenior adviser to the CCP, is correct to empha-size that China’s rise since it embarked on a pol-icy of openness in 1978 has been peaceful—inthe sense that it “has been driven by capital, tech-nology, and resources acquired through peace-ful means.” Indeed, “the most significant strate-gic choice the Chinese have made,” says Zheng,“was to embrace economic globalization ratherthan detach themselves from it.”48

Much of China’s economic reform has beenbottom-up rather than top-down. The peoplethemselves want a better life and greater eco-nomic and personal freedom. U.S. foreign poli-cy must respect those desires and recognize thatultimately freedom for the Chinese people willdepend on the choices they make.

Yasheng Huang, a professor of interna-tional management at MIT, has emphasizedthe weakness of China’s institutions and hasrecommended strengthening private proper-ty rights. According to Huang:

The central government has consistentlybet on the wrong horses. It supported thetraditional SOEs [state-owned enterpris-es] which, despite their entrenched posi-tions, early market leadership and abun-dant resources, have performed poorly.The resources that could have been usedto finance efficient businesses have beenwasted on the state-owned enterprises . . . .Massive investment booms have fuelledeconomic growth but the booms are notsustainable in the long term. China’s lead-ers recognise this. Now they need toencourage privatisation.49

Conclusion

The message that Congress should sendChina is the message Liu Junning, an inde-

pendent scholar in Beijing, underscoredwhen he wrote,

Whether China will be a constructivepartner or an emerging threat willdepend, to a very great extent, on thefate of liberalism in China: a liberalChina will be a constructive partner; anationalistic and authoritarian Chinawill be an emerging threat.50

Needlessly politicizing U.S.-China trade andbashing China will result in the rise of crudeand anti-American nationalism, and the threatof war could become a reality. That would be atragedy for world peace and prosperity.

To avert that disaster, policymakers should

• treat China as a normal great power, notas an adversary;

• ensure that only those commercialtransactions that truly threaten nation-al security are blocked, which means ajudicious use of CFIUS and legislativepower;

• continue to liberalize U.S.-China rela-tions and help China meet its WTOcommitments, including protection ofintellectual property rights;

• recognize that advancing economicfreedom in China reduces the possibili-ty of conflict and increases personalfreedom; and

• deepen the U.S. commitment to freetrade as a fundamental human right.

The United States can do more to spreadthe ethos of liberty by setting high standardsat home than by looking for an enemy abroad.Our energy security, as well as China’s, willdepend on sound free-market policies, not ondestructive protectionism.

NotesThe author thanks Christopher Preble, GeneHealy, Justin Logan, Dan Griswold, and JudeBlanchette for helpful comments on earlier ver-sions of this study.

11

The United Statescan do more tospread the ethosof liberty by setting high standards athome than bylooking for anenemy abroad.

1. For a discussion of the Pentagon’s 2005 AnnualReport, see Ted Galen Carpenter and Justin Logan,“The Pentagon’s Surprisingly Sober Look atChina,” National Interest, August 2005. AlthoughCarpenter and Logan view the report as mostly bal-anced, they contend that the Defense Department’sestimate of PRC military spending, $90 billion byyear-end, far exceeds more reasonable estimatesfrom the RAND Corporation, which expectsChina’s defense spending to range between $31 bil-lion and $38 billion in 2005.

2. Frank J. Gaffney Jr., “‘CNOOCered’: The AdverseNational Security Implications of the ProposedAcquisition of Unocal by the China NationalOffshore Oil Corporation,” Testimony submittedto the House Armed Services Committee, July 13,2005, www.centerforsecuritypolicy.org/GaffneyChinaTestimonyf7122.pdf.

3. Quoted in Brody Mullins and Dennis K. Berman,“Republicans Urge White House to Review Cnooc’sUnocal Bid,” Wall Street Journal, June 29, 2005, p. A4.

4. David Greising, “China Scraps Its Unocal Bid,”Chicago Tribune, August 3, 2005, pp. 1, 8; and HouseCommittee on Resources, “Conference CompletesWork on Energy Policy Act,” news release, July 26,2005, http://resourcescommittee.house.gov/Press/releases/2005/0726energybill.htm.

5. “CNOOC Bows Out of Unocal Bidding amidPolitical Furor,” Investor’s Business Daily, August 3,2005, p. A1.

6. Quoted in Matt Pottinger et al., “Cnooc DropsOffer for Unocal, Exposing U.S.-Chinese Tensions,”Wall Street Journal, August 3, 2005, p. A8.

7. Albert Keidel, “China’s Growing Pains Shouldn’tHurt Us,” Washington Post, July 24, 2005, p. B5.

8. See “Detailed Amendments to the Constitution,”March 15, 2004, www.chinaembassy.se/eng/xwdt/t101768.htm.

9. Jasper Becker, The Chinese (New York: FreePress, 2000), p. 157.

10. Charles Hutzler, “China Promotes ‘Peaceful Rise’to Quell U.S. Fears,” Wall Street Journal, September13, 2005, p. A15.

11. Quoted in Robert J. Samuelson, “China’s OilBid: A Battle to Avoid,” Washington Post, July 6,2005, p. A17.

12. Quoted material from House Resolution 344,June 30, 2005, http://thomas.loc.gov/cgi-bin/query/D?c109:1:./temp/~c109nZltvE.

13. Bernard A. Gelb, “Unocal Corporation’s Oil

and Gas,” Congressional Research Service (CRS)Report for Congress, RS22182, July 1, 2005, p. 2.

14. Quoted in Russell Gold, Matt Pottinger, andDennis K. Berman, “China’s Cnooc Lobs in RivalBid to Acquire Unocal,” Wall Street Journal, June23, 2005, p. A9.

15. Thomas Donnelly and Melissa Wisner, “ChinesePower Play,” Weekly Standard, July 29, 2005, www.aei.org/include/pub_print.asp?pubID=22923.

16. Kevin A. Hassett, “CNOOC Episode UnitesProtectionists and Hawks,” Bloomberg, August 8,2005, www.aei.org/publication22971.

17. Dick K. Nanto, James K. Jackson, and LawrenceKumins, “CNOOC, Ltd. Bid for Unocal,” CRSMemorandum, July 11, 2005, p. 4.

18. It is interesting to note that Chinese energycompanies are subject to domestic price controlsand, as a result, have been selling their crude oilabroad for a profit. So China itself is diverting“strategic assets” to where they fetch the highestprice. Why was Congress worried that CNOOCwould act differently? Meanwhile, the shortagesand long lines at gasoline stations in China,caused by below-market prices, have led to thepartial relaxation of price controls. So Chinaappears to be learning the lessons the UnitedStates painfully learned from imposing price con-trols in the 1970s. See Peter Wonacott, “ChinaEases Shortage at Gas Stations,” Wall StreetJournal, August 19, 2005, p. A11; and “China DoesCaternomics,” editorial, Wall Street Journal, August19, 2005, p. A12.

19. See Holman W. Jenkins Jr., “China Joins theClub,” Wall Street Journal, July 27, 2005, p. A13.

20. Excerpted from the July 13, 2005, audiotapesof the hearing.

21. Neil King Jr., Greg Hitt, and Jeffrey Ball, “OilBattle Sets Showdown over China: Cnooc’s Offer forUnocal Raises Stakes in Conflict over Sino-U.S.Ties,” Wall Street Journal, June 24, 2005, p. A.10; andNanto, Jackson, and Kumins, pp. 6–7. For moreinformation on CFIUS, see www.treas.gov/offices/international-affairs/exon-florio.

22. Quoted in Loretta Ng, “Citing ‘PoliticalEnvironment’ Cnooc Backs Off Its Bid to AcquireUnocal,” New York Sun, August 3, 2005, p. A7.

23. Statement available at http://tancredo.house.gov/pressers/0706UnocalChinaScript.htm.

24. See Samuelson, p. A17.

25. Jerry Taylor, Written testimony submitted to the

12

House Armed Services Committee, session on“National Security Implications of the PossibleMerger of the China National Offshore Oil Corpor-ation with Unocal Corporation,” July 13, 2005. Seealso Jerry Taylor, “CNOOC Bid for Unocal NoThreat to Energy Security,” Cato Institute Center forTrade Policy Studies Free Trade Bulletin no. 19, July19, 2005.

26. Pottinger et al., p. A8.

27. Quoted in “Unocal Shareholder, PSAM,Questions Chevron Payments to Key CongressionalOpponents of CNOOC Bid for Unocal,” PRNewswire, July 24, 2005, http://news.findlaw.com/prnewswire/20050724/24jul20051121.html.

28. Gaffney.

29. Reuters, “Power Tussle: U.S. Warns China onIran Oil,” Financial Express, September 7, 2005,www.financialexpress.com/print_latest.php?content_id=101772.

30. H.R. 1450, 109th Cong., 1st sess., March 17,2005, http://thomas.loc.gov/cgi-bin/query.

31. See Brink Lindsey and Daniel J. Ikenson,Antidumping Exposed: The Devilish Details of UnfairTrade Law (Washington: Cato Institute, 2003).

32. Quoted in Chen Xu, “Wen: Exchange Rate toStay Stable,” China Daily, June 27, 2005, p. 1.

33. See Ted Galen Carpenter and James A. Dorn,“Relations with China,” in Cato Handbook on Policy(Washington: Cato Institute, 2005), pp. 614–15.

34. James A. Dorn, “Trade and Human Rights:The Case of China,” Cato Journal 16, no. 1 (1996):77–98.

35. Alan Greenspan, “China,” Testimony beforethe Senate Committee on Finance, June 23, 2005,www.federalreserve.gov/boarddocs/testimony/2005/20050623/default.htm.

36. Nicholas R. Lardy, “United States–China Ties:Reassessing the Economic Relationship,” Testimonybefore the House Committee on InternationalRelations, October 21, 2003, www.iie.com/publications/papers/lardy1003.htm. Lardy notes that in1982 the average tariff rate on imports into Chinawas 55 percent, but it had fallen to 15 percent inearly 2001, prior to China’s entry into the WTO laterthat year. Today rates average about 10 percent.

37. James Gwartney and Robert Lawson with ErikGartzke, Economic Freedom of the World: 2005 Annual

Report (Vancouver, B.C.: Fraser Institute, 2005), p. 18.

38. Erik Gartzke, “Economic Freedom and Peace,”in ibid., p. 29.

39. Quoted in “Bush: Sino-U.S. Relations ‘Vibrant,Complex,’” China Daily, July 20, 2005, www2.chinadaily.com.cn/English/doc/2005-07/20/content_461769.htm.

40. Robert B. Zoellick, “Whither China: FromMembership to Responsibility?” Remarks to Nation-al Committee on U.S.-China Relations, New York,September 21, 2005, www.state.gov/s/d/rem/53682.htm.

41. Liu Jianfei, “Sino-U.S. Ties Vital to Peace,Stability,” China Daily, September 9, 2005, www.chinadaily.com.cn/english/doc/2005-09/09/content_476370.htm.

42. Lee Hsien Loong, “Engaging a New Asia,” Speechby the prime minister of Singapore to the U.S.-ASEAN Business Council, Washington, July 12,2005, http://app.mfa.gov.sg/internet/press/view_press_print.asp?post_id=1380.

43. Quoted in Patrick Barta and Matt Pottinger,“Why Cnooc May Not Be Such a Big Threat,” WallStreet Journal, June 30, 2005, p. A10.

44. Hassett.

45. Baron de Montesquieu, The Spirit of the Laws,trans. Thomas Nugent (New York: Hafner Publish-ing, 1966), Book XX (2), p. 316.

46. For a discussion of the Taiwan issue, seeCarpenter and Dorn, pp. 611–12; and Ted GalenCarpenter, America’s Coming War with China: CollisionCourse over Taiwan (New York: Palgrave/Macmillan,2005).

47. Joseph J. Borich, ed., CRC Update (WashingtonState China Relations Council) 7, no. 4 (July 2005),www.wscrc.org/chinaupdate.

48. Zheng Bijian, “China’s ‘Peaceful Rise’ toGreat-Power Status,” Foreign Affairs 84, no. 5 (Sep-tember/October 2005), p. 20.

49. Yasheng Huang, “China’s Growth MasksWeaknesses,” Financial Times, April 23, 2004, p. 13.

50. Liu Junning, “The Intellectual Turn: TheEmergence of Liberalism in Contemporary China,”in China’s Future: Constructive Partner or EmergingThreat? ed. Ted Galen Carpenter and James A. Dorn(Washington: Cato Institute, 2000), p. 60.

13

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