By Rob Nichols

Senior U.S. and Chinese officials are due to sit down in Beijing on Thursday for the U.S.-China Strategic and Economic Dialogue. Despite the diplomatic tensions during negotations about a leading dissident, Chen Guangcheng, preparation for the dialogue continued.

These meetings are vital, setting the framework for coordinating bilateral policy. U.S. financial services firms have strongly urged Washington officials to make sure China’s continued economic modernization — including greater foreign participation — is the central issue.

President George W. Bush and President Hu Jintao first set up a bilateral economic dialogue in 2006. A key focus was reform of China’s financial system — and significant progress was made. The Obama administration, however, expanded the dialogue’s scope to include noneconomic issues. They also reduced the number of meetings each year.

It is now essential that financial reform be restored as the central focus. This is particularly true given the necessity of greater financial reform for China’s continued growth and diversification — and the importance of China’s expansion to U.S. manufacturers, service providers and farmers.

Specific issues at the talks should include eliminating restrictions on corporate form, geographic expansion and product offerings; eliminating arbitrary caps on foreign investment in Chinese financial companies; ensuring that foreign financial participants and investors receive the same treatment from regulators as domestic entities; improving regulatory and procedural transparency; developing a more liquid corporate bond market; and allowing foreign companies and brokers to operate more effectively to support China’s goals in other areas, such as liability reform and emerging technologies.

China is America’s third-largest export market and the largest market for U.S. products outside North America. U.S. exports to China have expanded sixfold since 2000 and by 50 percent since 2008. They are increasing at seven times the pace of U.S. exports to anywhere else in the rest of the world.

Access to China’s growing middle class and business sector now offers enormous opportunity to U.S. manufacturers, service providers and farmers. It has clear implications for strong economic expansion and job creation in America.

But this is all threatened because the world’s fastest-growing economy is supported by one of the world’s least-developed and inefficient financial systems.

Capital and credit are the lifeblood of any economy. They fund the investment, research and risk-taking that fuels competition, innovation and productivity. An effective financial system — the cardiovascular system of that lifeblood — is essential to the long-term health and vitality of any economy.

China’s underdeveloped financial system, however, represents a serious problem to the continued growth and diversification of its economy and, therefore, to the U.S. and global economies. Fortunately, there is an opportunity to change that.

China’s leadership acknowledged during the National People’s Congress last March that its 30-year-old manufacturing-for-export economic model has left it vulnerable to slowdowns in external demand. The recessions in the United States and double dip in Europe have made this clear.

In response, China’s leadership is now talking about a more balanced economic model. It wants to rely less on exports and more on internal demand — primarily, a more active Chinese consumer.

A consumption-based Chinese economy is in U.S. interests because it could significantly expand demand for U.S.-made products and services.

Consider, the U.S. exported $66 billion in goods to Japan last year and $104 billion to China. But China is 10 times the size of Japan. If China’s 1.3 billion citizens consumed U.S.-made products at the same rate as Japan’s citizens, the U.S. would export about $700 billion to China annually. That $400 billion trade deficit could turn into a $300 billion surplus.

This can’t happen overnight. But the trend is already compelling. China’s import rate grew by nearly 40 percent in the year ending in February — twice the rate of its export growth. Exports to China from almost every U.S. state and congressional district have grown exponentially, The Washington Post reported.

But accelerating this shift to a more consumption-based Chinese economy requires a more modern financial sector. Specifically, it requires sophisticated financial products and services — personal loans, credit cards, mortgages, pensions, insurance products and retirement security products — that can eliminate the need for precautionary savings and facilitate consumption.

China’s consumers now save as much as half their incomes because most don’t have access to such products and services.

China’s consumption-focused development plan was praised in February in a joint report from the World Bank and the Development Research Center of the State Council, an influential Chinese government think tank. World Bank President Robert Zoellick called China’s economic model “unsustainable,” warning that without major reforms, China faces the prospect of economic crisis.

The report’s reform priorities emphasize “commercializing the banking system, gradually allowing interest rates to be set by market forces, deepening the capital market and developing the legal and supervisory infrastructure to ensure financial stability and build the credible foundations for the internationalization of China’s financial sector.”

Premier Wen Jiabao confirmed in a recent speech that China seeks more balanced and sustainable development. “We will move faster,” Wen said at the NPC in March, “to set up a permanent mechanism for boosting consumption.”

As part of the restructuring strategy, Wen seemed to endorse further reform of China’s financial system. “We will improve both initial public offerings,” he said, “and ensure better protection of return on investors’ money and their rights and interests.”

The fastest way for any developing economy to acquire a modern financial sector is to import it. That means allowing foreign financial institutions to establish in-country operations by setting up branches and subsidiaries, joint ventures with domestic institutions, and cross-border mergers and acquisitions. These foreign institutions can bring expertise and best practices.

China, unfortunately, continues to impose restrictions on foreign financial institutions — including U.S. institutions — with regard to market access, licensing, corporate form, branching and permitted products and services. Foreign institutions are also still subject to discriminatory treatment by Chinese regulatory agencies.

Given the importance of the U.S.-China relationship to both nations — and the global economy — both Beijing and Washington must seek to make increasing China’s financial reform the focus of their talks this week.

Rob Nichols is president and chief executive officer of the Financial Services Forum. He is also chairman of the Engage China coalition.