The Financial Silk Road

A Most Favored Nation

– On January 24, 1980, after the US-China Science and Technology Cooperation Agreement (see Bits of History #2) and the Equity Joint Venture Law—which gave foreign direct investments in China legal status—the U.S. Congress granted China the status of Most Favored Nation (MFN). This effectively ended the Smoot-Hawley Act of 1930—which had imposed high tariffs on Chinese imports.

China’s reforms and further market opening, however, were still insufficient to counter the political pressures of the 1974 Trade Act. In general, the early years of trade relations were marked by a clear imbalance in favour of the United States. According to many observers, e.g., James Bacchus—a founding member and chairman of the World Trade Organization’s Appellate Body—the disputes between China and the US were simply a necessary stage in the commercial relations between two major powers.

In the first half of the 1980s, China experienced its first major surge in trade. Total trade rose from around $20 billion in 1978 to over $60 billion in 1985. Over the same period, U.S.-China trade expanded from $1 billion to $7 billion. Foreign direct investment in China also grew modestly but steadily, driven mainly by the creation of the first four Special Economic Zones in Guangdong and Fujian provinces in 1980 and by new tax incentives introduced under economic reforms. At the same time, the United States eased its export controls.

In 1983, the Reagan administration placed China in category V, a designation for allied trade partners under U.S. export control rules. This allowed American high technology to enter China more freely in the second half of the 1980s. However, this move did not resolve issues over patents. Intellectual property was one of the main points of contention. China, for instance, initially did not recognise rights over software and chemical processes. Even so, trade relations continued to expand.

In September 1985, the United States, Japan, West Germany, France, and the United Kingdom signed the Plaza Accord in New York. The objective was to weaken the U.S. dollar against the Japanese yen and the Deutsche mark. The strong dollar of the early 1980s had made U.S. exports less competitive and widened the trade deficit. It also limited Chinese companies’ ability to buy U.S. technologies and advance the long-term plans developed by Kissinger and his Chinese counterparts.

Through coordinated currency interventions, the agreement succeeded in lowering the dollar’s value. This encouraged U.S. companies to expand overseas production and investment. Major American corporations soon began opening subsidiaries in China, setting up production facilities through joint ventures with local companies or state agencies. General Motors, which had already opened a branch in Shanghai in 1984, was among the first. It was soon followed by Coca-Cola, Pepsi-Cola, Gillette, Heinz, General Foods, Eastman Kodak, and AT&T, among others.

Within the emerging trade system, Hong Kong played a decisive role. Roughly 30% of exports from the People’s Republic of China (PRC) passed through the small southern territory, which was still under British rule. The United States was the main destination for these goods. Chinese products were often shipped to Hong Kong, processed, relabelled, or simply resold before reaching final markets. This frequently inflated their value—by 40% to 100%—and created discrepancies in trade statistics.

The United States tracked which goods leaving Hong Kong originated in the PRC and included them in the U.S.-China trade balance. China, however, recorded the same goods in its trade balance with Hong Kong and could not determine precisely which items ultimately reached the United States.

To be clear, the issue is less about the origin of goods than about their pricing. Merchandise could not only be sold in the U.S. and Europe at higher, often unjustified prices, but it could also tap into larger financial and insurance markets. One key aspect of the modern Financial Silk Road is that finance does not merely facilitate trade; trade mechanisms are often designed to allow banks, investors, and insurers to create new, lucrative financial markets.

In any case, the re-export of goods to the U.S. remained a point of contention between Beijing and Washington for a long time, with China accusing the United States of distorting the actual figures of bilateral trade.

At the time, political debate focused primarily on the trade of specific technologies. By the mid-1980s, the list of dual-use technologies had grown to 128 pages, covering 240 products across ten categories, as defined by the 1979 Export Administration Act. Trade was expanding at an annual rate of 44% until China’s domestic austerity policies under Premier Li Peng sparked widespread protests. These culminated in the violent crackdown of June 4, 1989, against students in Tiananmen, Beijing—which threatened to halt China’s market-opening process.

The more radical members of the Chinese Communist Party sought to roll back relations with Western countries. In response, the United States, under President George H. W. Bush, imposed sanctions that blocked all exchanges conducted directly through government agencies, especially those involving military equipment. Western European countries took a similar stance. The United States and its European allies imposed sanctions on China, mainly targeting military sales, defence technologies, and government-to-government cooperation.

Diplomatic relations between the United States and China—formally suspended—were maintained discreetly through visits to Beijing by National Security Advisor Brent Scowcroft and Assistant Secretary of State Lawrence Eagleburger. U.S. political leverage centred on the threat not to renew China’s Most Favored Nation status, which the administration reviewed annually. While these measures signalled political condemnation, they did not affect broader economic relations, allowing private trade and investment to continue growing. Trade flows remained largely intact.

This dual approach highlighted the limits of West’s attempt to balance human rights concerns with strategic and economic interests. Although widely condemned, the Tiananmen events sparked a positive interpretation in the minds of many Western entrepreneurs and strategists: China appeared stable. Political and social stability was seen as essential for the massive inflows of investment envisioned by Western industrialists. They needed reassurance that they could move beyond the challenges of U.S. and European trade unionism, to reach a safe shore where a controlled, cheap and efficient work force could reshape their business operations and profits. By the early 1990s, foreign direct investment in China had entered a new era.