Self-Inflicted China Syndrome

The good news of a strong economic recovery in the third quarter wasn't enough to prevent U.S. authorities from again capitulating to domestic protectionists' demands and imposing import quotas on some Chinese textiles last month. Although this move directly affects a very minor portion of the U.S.-China trade, it shouldn't be taken lightly. It could give further momentum to recent unwarranted China bashing: that China is an unfair competitor and is the chief cause of job losses in the U.S. The Bush Administration's decision has opened the gates, and it's only a matter of time before the White House is inundated with demands from other interest groups that want their piece of the protectionist pie. This situation could become very destructive if Chinese authorities give in to the temptation of squaring off in a trade war. Before it's too late, it's imperative that the U.S. stop using China's export vigor to exorcise its external imbalances.

See the Forest, Not Just the Trees of Trade

It's true that China's trade surplus with the U.S. has reached more than $100 billion a year. But it doesn't follow that losses in U.S. manufacturing jobs in recent years have been caused by China's protectionism, as some American politicians are wont to claim. The real reasons are much more complicated.

The U.S. trade deficit is large because the U.S.' national expenditure exceeds its national income, which is mostly a matter of domestic macroeconomic policy. This gap is reflected in a current account deficit that will be close to $550 billion this year. China figures in a big portion of this deficit because it is now the U.S.' second-largest trading partner and because, thanks to its openness to trade and foreign investment, China is taking advantage of its own cheap and increasingly productive labor force to become a leading player in the assembly of manufactured goods for world markets. Even so, Chinese exports have not, in general, displaced American goods in global markets. Rather, China's world market share has grown at the expense of other labor-abundant countries that, through their own decisions, have failed to enhance their competitiveness as quickly as China has. The new Asian giant exports a lot, but it also imports a lot. Thus its total trade surplus is relatively modest.

Contrary to popular belief, China has an increasingly open economy. Its ratio of trade--exports plus imports--to gross domestic product will be close to 50% this year. Its average import tariff is much smaller than those of most other large emerging economies. China has seen its total imports grow exponentially in recent years; it is now the third-largest importer in the world. And, yes, the U.S. has benefited from this evolution. Since 2001 China has been the most dynamic market for U.S. exports: This year alone U.S. exports to China have grown by more than 20%. If anything, overall trade with China has been supportive of--not destructive to--U.S. economic activity. Furthermore, U.S. companies have benefited from China's policy of tapping world markets. One-fourth of China's largest exporters are American companies, not to mention those that are already obtaining a significant chunk of their total revenues from sales in China's domestic market.

Unfair Monetary Policy?

Inadequate evidence of China's alleged trade protectionism has made China bashers concentrate their batteries on that country's exchange-rate policy. They accuse China of fostering its exports by manipulating its currency, the yuan, and demand that the yuan be allowed to float at market rates. President Bush himself has asked for China to have a "monetary policy which is fair." Leaving aside the question of whether a freely floating yuan would be fair to China--it wouldn't be, of course--it's hard to see, frankly speaking, how China's monetary policy could at this time be more fair to U.S. interests or to the global economy at large than it already is. A frequently overlooked fact is that China keeps its currency peg by having its central bank buy surplus dollars (which stem from its current account surplus and inflows of direct foreign investment) and reinvest them abroad, essentially in U.S. Treasury bonds. By doing this, China is helping to finance the U.S.' huge fiscal and current account deficits. It is also in a sense replicating the U.S.' very expansive monetary policy, thus helping to invigorate global economic growth, something that Europe and Japan, for the most part, have failed to do.

Were China to suddenly stop buying surplus dollars, upward pressure on U.S. bond yields would mount. Other foreign investors in U.S. securities would follow suit, and before long interest rates would rise significantly. This would have disastrous effects on consumers and business expenditure in the U.S. The present recovery would prove quite short-lived.

Needless to say, it's in nobody's interests--least of all China's--to jeopardize U.S. economic growth. Whether the China bashers like it or not, the American and Chinese economies have become interdependent to no minor extent--which is, actually, good news for global peace and prosperity. This fact seems to be well grasped in Beijing, at least sufficiently so for China to avoid a foolish and self-destructive trade or financial misstep. But on this side of the Pacific that fact needs to be better understood. In economics, as in many other aspects of life, you can't have your cake and eat it, too!