Since the normalization of relations between the People's Republic of China (PRC) and the United States in 1979, the two governments have conducted a number of bilateral negotiations aimed at establishing closer economic ties and greater mutual understanding. These negotiations have yielded several trade- and investment-related agreements including a bilateral trade agreement, several bilateral income tax agreements, and a bilateral investment guarantee agreement. However, after five years of intermittent negotiations, the two sides have yet to come to terms on a bilateral investment treaty (BIT).

As the modern day successor to the post World War II treaties of Friendship, Commerce, and Navigation (FCN), a BIT is a more specialized reciprocal agreement to encourage investment and provide certain guarantees and formal protection for investment activities in a foreign country. BIT negotiations with the PRC arose from three sources. First, they follow a general campaign formulated by the U.S. government in the late 1970s and initiated in 1981 to negotiate these treaties with developing countries. Second, they respond to private business pressure, both by individual companies and through organizations like the National Council on U.S.-China Trade, to improve treatment of foreign investment in China. And third, they reflect the PRC government's own desire to improve the investment climate in China so as to attract more foreign capital. However, since the initial negotiations began with China in mid-1983, six rounds of formal talks and several informal "exchanges of view" have not borne fruit. Efforts to reach an agreement have bogged down because of apparent strong disagreement on the fundamental principles underlying the proper protections of foreign investment.

To a certain extent, the conflict reflects long-standing differences of opinion between industrialized capital exporting countries and capital- importing developing countries. But closer examination reveals that this explanation is incomplete. Indeed, the U.S. has already successfully negotiated and signed BITs with a number of other developing countries. Likewise, the PRC has already signed its share of agreements with industrialized countries.

The PRC's socialist planned economic system and extensive state ownership are important characteristics that distinguish it from other U.S. BIT partners. Government price-setting and controlled allocation of resources in the PRC are an anathema to many foreign investors who want a flat playing field to compete on. In part precisely because of China's uniqueness, the office of the U.S. Trade Representative (USTR), which co-chairs the U.S. negotiating team with the Department of State, seems to have singled out negotiations with the PRC as a forum to establish a precedent for future BITs with other socialist countries.

Negotiations with China are unique for other reasons. First, because of the well-known abuses of China's sovereignty by Western countries in the nineteenth and early twentieth centuries, China's notion of the protective reach of the principle of sovereignty is generally much broader than that of Western countries. Consequently, Chinese leaders are still unusually reluctant to discuss any agreement that they believe might threaten that sovereignty. Second, the relatively undeveloped condition of the PRC legal system not only causes uncertainty among foreign investors, but at the same time may also prevent the adoption of any complex international agreements unsuited to the internal legal development.

These fundamental differences cause disagreements during negotiations in three important areas: 1) the level of treatment to be accorded to foreign investments, 2) expropriation processes and compensation, and 3) dispute settlement. These areas will be discussed in part III below. But in order to further understand the context in which these issues arise, it is necessary, first, to review the background of U.S. government efforts to protect American investments abroad and, second, to present a summary of China's past experiences with and attitudes towards foreign direct investment (FDI).