* China drops preconditions for talks, U.S. says
* U.S. business groups welcome announcement
* Testy exchange over Snowden amid productive talks
By Paul Eckert and Anna Yukhananov
WASHINGTON, July 11 The United States and China agreed on Thursday to restart stalled negotiations on an investment treaty, with Beijing dropping previous efforts to protect certain sectors of its economy from the start.
The agreement to resume negotiations was welcomed by the U.S. business community as a major advance during annual Strategic and Economic Dialogue talks in Washington, which have often produced few agreements of substance.
Top officials from both sides strived to project a friendly, businesslike tone as they tried to build what China calls a "new model of major country relations" between the world's two biggest economies in the first year of Chinese President Xi Jinping's mandate.
But talks struck a sour note over China's handling of former spy agency contractor Edward Snowden, who hid out in the Chinese territory of Hong Kong last month as he revealed a secret U.S. surveillance program before fleeing to Russia.
Disputes over cyber security topped the agenda going into this year's talks, which were launched in 2008 to manage a relationship that was growing more complex and tense with China's emergence as major economic and military power.
U.S. Treasury Secretary Jack Lew hailed the investment treaty commitment as a sign of positive change in Beijing as China retools its economic growth model away from heavy investment and exports toward growth driven by consumption.
"China announced its intention to negotiate a high standard bilateral investment treaty with us that will include all stages of investment and all sectors - a significant breakthrough, and the first time China has agreed to do so with another country," he said as the talks concluded.
China and the United States began negotiations on a pact to govern bilateral investment in 2008 under then-U.S. President George W. Bush, but discussions were put on hold after President Barack Obama took office the following year.
Previously, Beijing had agreed to talks only if certain Chinese industries, especially in its service sector, were exempt. But it agreed to drop blanket restrictions for the current talks, a U.S. Treasury official said.
The official, briefing reporters at the U.S.-China economic talks, said the move was an encouraging sign the world's second-largest economy was willing to open up more sectors to foreign competition.
Chinese Commerce Minister Gao Hucheng told reporters China and the United States shared "a common purpose, which is to try to find ways to reduce and mitigate differences and barriers that both sides place in our trade and investment relations."
Explaining China's motives for reopening the investment talks, Chinese Vice Finance Minister Zhu Guangyao said China had about $20 billion of direct investment in the United States and $1.2 trillion in U.S. treasury bills.
"With such an extensive investment relationship, it is necessary for the two sides to have an institutional environment for the protection of these investments," he told reporters.
In addition, Zhu said, "Business leaders from China and the United States have a strong desire to invest in the market of the other. They both want an open and more transparent market."
Analysts and U.S. officials said another factor was a relative reversal of fortunes from previous years, with the United States enjoying economic recovery while China grappled with a slowing economy that showed the limits of its model.
"This set of meetings, as many of the meetings that I've had in recent months have had this character to them, that there's a renewed recognition and respect for the resilience of the American economy," said Lew.
U.S. business groups welcomed the agreement to resume negotiations, but warned that both sides still faced many other tough issues and that negotiations on a treaty could be lengthy. Any pact would need to be ratified by the U.S. Senate.
"The U.S. Chamber called for this last year as a pre-condition, and we are very pleased that both governments rose to the challenge," said Myron Brilliant, head of international affairs at the U.S. Chamber of Commerce.
BARRIERS TO BUSINESS
U.S. investors face barriers or ownership limits in about 90 Chinese sectors, while Chinese companies seeking to invest in the United States often fear a political backlash in Congress or rejection on national security grounds.
"If China negotiates a treaty that not only protects investments after they are made but also improves U.S. investors' access to the Chinese market, this would be a real breakthrough," said Michael Smart of consultants Rock Creek Global Advisors, who worked on investment issues in the Bush White House.
The talks opened just weeks after Snowden' disclosure of extensive U.S. electronic surveillance of American citizens and foreign countries, including China, which undercut years of complaints from Washington about Chinese hacking.
In remarks at the end of the talks, the United States said it had made clear its displeasure that Chinese authorities allowed Snowden, on the run in Hong Kong, to leave for Moscow rather than send him back to face U.S. justice.
"We were disappointed with how the authorities in Beijing and Hong Kong handled the Snowden case, which undermined our effort to build the trust needed to manage difficult issues," U.S. Deputy Secretary of State William Burns said.
Chinese State Councilor Yang Jiechi swiftly brushed off Burns' criticism of Hong Kong, the former British colony that h is a special administrative region of China. Hong Kong answers to Beijing on matters of foreign policy, but unlike China, it has an extradition treaty with the United States.
"The central government has always respected the Hong Kong SAR government's handling of cases in accordance with law," he said.
"The Hong Kong government handled the Snowden case in accordance with law, and its approach is beyond reproach," Yang said about the decision to not detain Snowden.
Douglas Paal, of the Carnegie Endowment for International Peace, said Snowden's case "makes it impossible for any countries to make concessions to the United States for the time being, because we look like big cyber offenders."
Burns said the two powers "need to reach a shared understanding of the rules of the road" in cyber space and repeated U.S. complaints about the cyber theft of intellectual property that most American experts blame on China.
"The cyber-enabled theft of trade secrets, intellectual property, and confidential business information is unacceptable," he said.
Chinese leaders did not publicly address the cyber-theft issue during the Washington talks, although Gao said China was determined to improve protection of intellectual property.
A U.S. official said that Washington's lobbying on the issue had made some headway - in part because China was generating more of its own intellectual property.
"What we're seeing is an acknowledgment that this realm of activity is distinct, is important and needs to be addressed," said the official, speaking on condition of anonymity.
Both countries' officials said they were clear-eyed about the differences in political system, wealth and values that divided them, saying the key was to manage relations.
"Of course, because of differences, there's a need for us to make rules. And to formulate those rules, we need to have dialogue," Chinese Vice Premier Wang Yang said in a dinner speech late on Thursday.