America’s China Worries – Part II

China has emerged as both mammoth producer and consumer, and that means more countries, including key US allies, depend on China for their economic well-being. The second article in this three-part series on worries besetting China-US relations explores how one nation’s expanding influence over global trade policy diminishes the other’s influence and flexibility. As the US trade imbalance with China surges to unprecedented heights, the Bush administration has brought a case before the WTO over China allegedly subsidizing its industries. Representing a dramatic reversal of Washington’s longstanding neglect of the issue, the conflict is unlikely to evolve into a full-fledged trade war, according to columnist Bruce Stokes. Powerful US firms with large operations in China have much to lose from any trade war, and the US needs Chinese cooperation to end the nuclear threats posed by North Korea and Iran. Stokes points out that any signs of increased tension should not be mistaken for a breakdown in relations. Instead, the Bush administration’s ultimate goal could be to prevent Congress from enacting any protectionist legislation. – YaleGlobal

America’s China Worries – Part II

Hobbled by a rising trade deficit and massive debt, Washington seeks some leverage with Beijing
Bruce Stokes
Thursday, February 8, 2007
Falling prices, rising debt: American customers snap up Chinese-made

goods while the US deficit is growing

WASHINGTON: The decision by the Bush administration to bring a case before the World Trade Organization against China’s alleged subsidies of its industries is the most aggressive and potentially most significant trade action against China by any of its trading partners since the nation became a major player in the global economy. As a formerly state-dominated economy, subsidies and their competition-distorting consequences remain a fact of everyday economic life in the Chinese marketplace. Unless China succeeds in resolving these concerns, an adverse WTO ruling against China would permit Washington to levy unprecedented import duties on Chinese products.

The administration’s action, after six years of benign neglect of US-China trade relations, is a conscious effort to forestall even tougher sanctions against China by the newly-elected Democratic Congress. Yet, despite the precedent-shattering implications of the US filing the WTO case, a full-fledged trade war between Washington and Beijing is unlikely. US-China trade tensions are mild compared to those between Japan and the US during the 1980s. Politically-powerful multinational corporations have conflicting interests with regard to China. And Americans, as debtors, can’t afford to stick their thumbs in the eye of their Chinese creditors.

Concern in Washington about China has been growing for some time, reflecting the unprecedented $214 billion US trade imbalance with China (through November 2006), a 16 percent increase over the first 11 months of 2005. By comparison, in 1987 at the height of US-Japanese trade tensions, the total US deficit with Japan was only $56 billion.

Moreover, the composition of the US trade balance with China is evolving. Whereas once China sold America straw goods, toys and shoes, increasingly the Chinese export high-value goods that Americans still make. China’s trade surplus with the US in electronics, for example, exploded in the first 11 months of 2006, up 165 percent over the comparable period in 2005. And the auto-parts deficit with China was up 29 percent in the first 9 months of 2006. These are politically sensitive segments of the economy.

In theory, the US could run a trade deficit with China and compensate by running surpluses with other countries. But, in reality, the US ran a $900 billion deficit with the world in 2006, equivalent to 7 percent of its economy and a quarter of that was with China alone.

No major economy has run a deficit of this magnitude for so long without a currency crisis. And that deficit will be difficult to reduce to something more sustainable unless there is significant reduction in its largest single component: the US imbalance with China.

Washington funds much of its current imbalance by borrowing from Beijing the dollars the Chinese have earned selling consumer goods to America. Almost all of this borrowing from China is through the sale of US Treasury securities – $347 billion as of November, 2006. Americans have to worry that in some future confrontation, Beijing might threaten to sell some of these highly liquid notes, driving up US interest rates overnight.

But China’s emergence as the global factory also has implications for US trade policy. Much of China’s surplus is a product of Chinese companies importing parts from Taiwan or elsewhere that are then assembled and exported to America. This role as the global-manufacturing middleman enhances Beijing’s influence throughout Asia. Thailand or Indonesia need China now more than they once did. Beijing’s recent aggressive pursuit of preferential trade agreements throughout Southeast Asia further draws these nations into the Chinese economic orbit.

Moreover, the emergence of China as both producer and consumer has meant that China, not the US, is now the largest trading partner for a number of American allies, including Japan, South Korea and Europe. As a result, Washington has relatively less influence over these governments on a range of issues.

These developments have seriously eroded American good will toward China. Two-thirds of Americans now worry that the rising power of China poses a threat to the US. And three in five think the US is not tough enough in its business relations with China. And surveys of Washington elites show that policymakers express more concern than the US public.

After doing little about this festering problem, the Bush administration now needs Chinese cooperation in confronting nuclear threats posed by North Korea and Iran.

By 2006, the worsening trade imbalance could no longer be ignored. With fanfare, the Bush administration launched strategic economic dialogue with the Chinese government, involving an unprecedented number of US cabinet members.

This initiative has yet to show results. Unless there is significant appreciation of the Chinese currency, promising a turnaround in the deficit, Democrats and many Republicans on Capitol Hill will want to demonstrate they are doing something to stem the bleeding.

The Chinese yuan is seriously undervalued, some economists estimate by more than 20 percent. Congressional imposition of tariffs on Chinese imports to compensate for this undervaluation has been threatened for some time, but is unlikely. Wall Street’s reaction would be decidedly negative. And Congress hates to enact measures that might adversely move financial markets.

More likely to pass is narrower legislation aimed at China. It was to preempt such Congressional moves that the Bush administration launched the WTO action against Chinese subsidies. Beijing offers a range of export tax rebates to Chinese companies, yet Washington trade lawyers privately acknowledge that verifying such subsidies may prove impossible in the opaque world of Chinese business-government relations. So the WTO case may prove a hollow gesture.

The thinking inside the administration is to initiate a number of such actions soon to defuse trade tensions before they become an issue in the 2008 US presidential campaign and avoid the embarrassment of a Sino-American confrontation immediately before the August 2008 Olympics in Beijing.

Any actions from Congress or the administration will be tempered by the mutually dependent nature of Sino-American trade and the conflicting self-interest of US multinational firms.

China’s exports are only now beginning to impact American industry – so the political backlash has yet to come. And China bashing may never be as severe as Japan bashing in the 1980s, if only because the US manufacturing sector is far smaller today, so fewer people face losing their jobs.

Moreover, one consequence of years of US investment in China is that Beijing now has hostages. Powerful American companies deeply involved in China have much to lose in a Sino-American trade war. They will lobby hard against meaningful trade action. Failure of the Bush administration to file a long-threatened WTO case against alleged Chinese failure to protect intellectual property rights – an action Hollywood once championed and now, at least in part, opposes – is an indication of the leverage such multinational firms exert in Washington.

Finally, as concerned as Americans are about Chinese economic power, they worry more about Beijing’s military might. China is a military and creditor superpower in a way Japan never was. Thus Beijing must be accorded deference, even if it galls many Americans.

Sino-American tensions will worsen because the underlying economic frictions have rubbed relations raw, as underscored by the WTO case. But a higher visibility for problems in the relationship should not be confused with a breakdown in relations. More skirmishes do not make a war. There is not yet the wherewithal or the leverage in Washington for a knockdown drag-out fight with Beijing over trade.

Bruce Stokes is the international economics columnist for the “National Journal,” a weekly Washington public-policy magazine.

© 2007 Yale Center for the Study of Globalization