The British Embassy to the Department of State


the situation in china

The position has again been examined by the competent departments in London in the light of the developments that have occurred since the review of December last. These developments all go to reinforce the tentative view already expressed that Communist domination of China must be regarded as inevitable.

In the accompanying summary the Foreign Office present their views on the measures which might be taken in defence of British economic interests in China. This Embassy would welcome the comments of the State Department on the assessment of the problems and on the proposed methods for meeting the probable threats to foreign interests.

[Annex 1]

Statement by the British Foreign Office

Measures in Defence of British Economic Interests in China

Continuation of paper on China attached to Sir Oliver Franks’ letter of 5th January 1949 to Mr. Lovett24

Economic Considerations

The following is an assessment of the major economic problems of a Communist-dominated China, and of possible ways of exploiting to our advantage any economic weaknesses that may emerge. The economic long-term policy of the Communists will be on normal Communist lines and will be directed towards land reform, state industrialisation and the expropriation or expulsion of foreign interests, but it is assumed that in the initial period economic difficulties will be so [Page 838] great that the Communists will perforce move slowly towards these goals, and accordingly that they may be disposed to tolerate foreign interests for a time.

Communist economic weaknesses can be summarised under the following heads:

The Communists will have great difficulty in balancing the budget, increasing taxation, diminishing expenditure and maintaining confidence in their currency. They will face the same threat of runaway inflation as the present government but may be expected to take more drastic steps to deal with it.
Food and Agriculture
Before the war China normally imported about one million tons of rice a year. This figure will be decreased if the Communists control Formosa, but rice supplies will be insufficient. Internal distribution is another problem (see under Transport below). Foreign agricultural machinery, of which the Soviet Union and the satellites cannot supply much, will probably be desired but not immediately essential, nor, owing to the nature of rice agriculture in China, necessarily indispensable.
Industrialisation will require foreign capital, foreign capital goods and foreign technical assistance. It is doubtful whether the Soviet Union and the satellites can provide much of this.
Adequate distribution of food supplies and economic prosperity depend on the improvement of internal communications and the maintenance of shipping facilities. The Communists will depend on foreign vessels for their overseas trade in any case, and for coastal trade if the present Chinese mercantile marine is denied them. Sufficient river transport will, however, be available. But vast quantities of supplies will be necessary to restore the war damaged railway system, and transport may well prove to be one of the Communists’ most serious weaknesses.
Minerals and Raw Materials
China will be almost entirely dependent on non-Communist sources for supplies of rubber, oil, and fertilisers. She will be deficient in raw cotton. The most serious mineral deficiencies will be the ferro-alloy metals.
Foreign trade has in the past been relatively unimportant in China’s economic life, and the Communists will no doubt continue the present Chinese policy of restricting imports to capital goods and basic essentials (oil, rubber, food, etc.). They may very probably wish to increase exports in order to be able to import more.

Although trade with China has lately been very small, non-Chinese merchant and industrial interests are established in China in such [Page 839] strength that they conduct a very large proportion of China’s trade with the rest of the world and operate a large number of industrial enterprises in China.

For example, the value of British commercial property alone was assessed in 1941 at £300,000,000 and to this must be added invisible earnings. This figure excludes subsequent war damage, but the present total value is still very considerable. If all non-Chinese interests were to cut their losses promptly and remove whatever property they could it would undoubtedly greatly increase the Communists’ difficulties, but from the point of view of the interests concerned the financial loss, as most of the property could not be got out, would be not much less than if the Communists took over all these interests in the first place without compensation. In any case it has been decided on political grounds that British interests should be supported in their desire to keep their foot in the door in China as long as possible, and on economic grounds it would be regrettable to cut ourselves off from a potentially vast market for British goods and a potentially important soft-currency source of supply of essential imports (including eggs, tea, broad beans, bristles, soya beans and flour, and tung oil). With the great internal need in China and our own need for soft currency supplies, potential trade if conditions were at all normal might be at least double pre-war.

The best hope for Western interests to maintain themselves for some time longer in China seems to be in the presumed Communist need for the continued functioning of the public utilities, insurance, banking, commercial and shipping agencies and industrial enterprises until the Communists forcibly exclude such operations. Whatever economic weapons may be at our disposal for the purpose of protecting our economic interests in China it is considered that they should be held in reserve for as long as the Communists are prepared to tolerate their functioning. The probable results of any attempt to bring economic pressure to bear during the first phase would be to expedite the coming of the second phase in which the Communists are likely to attempt some form of expropriation.

On the assumption that the existence of foreign economic interests will only be tolerated for as long as their continued functioning is considered by the Communists to be in their own interests, and that a stage will come when some form of expropriation will be attempted, it is clearly of the first importance that we and the other Powers concerned shall endeavour to agree on a common line in the face of this threat. Our objectives in any consultations which may take place should be:

to reach agreement with other powers to take no positive action for as long as Foreign interests remain reasonably unmolested;
to reach agreement in principle with the other powers concerned on the joint application of possible future measures of economic [Page 840] pressure against the Communists should these later prove necessary and expedient, on the understanding that they are in any case to be held in reserve until such time as the Communists begin to take definitely aggressive action against foreign economic interests. Action on these lines would not of course preclude the denial to China, by agreement with other Powers, of goods of strategic importance, where such denial would be effective. Ex hypothesi it is clear that any threats by British concerns to shut down their operations (even if concerted through the British Chambers of Commerce) would have little effect on the Communists. Any action would, therefore, have to be taken from outside China; and the summary of Communist economic weaknesses given above does not reveal any particularly strong card in our hand at the present time. The following possibilities present themselves:

(i) The licensing of exports from the U.K. to China

It is considered that such a system should be introduced only as a last resort, and in any case should apply only to certain materials which we know the Communists have particular need of. It would in any case be no use to introduce a licensing system except on the basis of agreement between the U.K. and other important potential suppliers, and it would obviously also be necessary to license exports to a number of Far Eastern ports outside China.

(ii) Oil Sanctions

It is possible that the denial to the Chinese Communists of oil supplies alone might prove to be a weapon of considerable value. Such a sanction could be applied effectively by agreement between the United Kingdom, the United States and the Netherlands.

(iii) The withdrawal of British shipping

This might prove an effective sanction but would be extremely difficult to operate since the licensing procedure for British vessels is totally unsuitable for such a purpose.

While Communist action against British interests in China may perhaps be delayed by suitable tactics, in the long run His Majesty’s Government are likely to be faced with a similar state of affairs as regards expropriated British interests to that in Eastern Europe today, only on a larger scale. By this time we may be better placed in regard to the supply of goods which the Communists most desire, and may therefore be able to minimise our losses, perhaps through a trade and compensation agreement, or if necessary, by threats to impose sanctions, or possibly by a combination of the two.

[Annex 2]

Addendum to British Embassy Memorandum

Approximate figures of exports of important raw materials and other articles from Hong Kong to North Korea between 1st January and 26th March 1949.

[Page 841]
Article Quantity Value HK dollars
From U.S.A.
Lubricating oils 120,000 Am. galls, plus 20.000 pounds 385,836
Glycerine 844 pounds 1,500
Machinery 12 cases 29,625
Motor vehicles 94 994,960
Rubber tyres and tubes of which a small quantity came from Japan 800,000
Auto parts (U.S.A., N. China and Manchuria) 421,768
Motor vehicles 5 69.500
Diesel oil 200 tons 49,000
Gasoline 294,710 Am. galls. 459,229
Glycerine unknown 45,707
Lubricating oils 335,900 Am. galls. 537,538
plus 190 tons 219,000
Auto parts 26 cases 50,000
HK $4,063,463
From Japan
Rubber tyres Unknown HK $50,000
From India
Shellac 1500 pounds HK $48,000
From Java and Singapore
Rubber 4872 piculs 404,200
Rubber unknown 339,060
HK $743,260
From the United Kingdom
Steel bars 70 bundles unknown
  1. Ante, p. 2.