Does China Pose an Economic Threat to the United States?Published: December 17, 2003 in Knowledge@Wharton
“Free trade is good … and in the long run it’s good for both the U.S. and China,” says Wharton finance professor Franklin Allen. “In the short run, there will be adjustment costs [such as lost jobs]. Protectionist arguments are designed to address the sort of problems that occur in the short run, but protectionism is like pushing against the tide.”
Thomas Rawski, professor of economics and history at the University of Pittsburgh, suggests that China’s economic development in many ways poses an opportunity for the United States. “It’s not that the benefits are unalloyed. Whenever we have changes in the economic structure, some parties are hurt. If the sun is shining, people can’t sell umbrellas. So should we say that the sun poses a threat to the economy because umbrella sellers perform poorly? This is the sort of discussion we are having in our public arena.”
China has recently been in the crosshairs of the Bush administration for pursuing policies that are said to hurt American companies and workers. Members of the administration and representatives of some manufacturing companies have asserted that the United States is under siege by China, which is the world’s most populous nation, has a red-hot economy and is a major supplier of goods to America. Factory jobs are disappearing in the United States as companies seek China’s bargain-basement wage environment, these critics say, adding that China dumps inexpensive goods in America that U.S. businesses simply cannot produce as cheaply.
On Nov. 18, the talk was accompanied by action when U.S. Commerce Secretary Donald Evans announced that the United States would impose quotas on brassieres, nightclothes and certain fabrics imported from China. On Nov. 26, the Commerce Department ruled that a TV maker in Tennessee was being harmed by unfairly priced color TV sets imported from China and that the department may impose duties as high as 46% on those sets.
A catfight over bras and bedclothes may be fun for headline writers; “bra brawl” was the way one magazine summarized the conflict. But it is hardly a laughing matter that there is rising tension between Beijing and a Republican administration that is ostensibly in favor of free trade, but has shown that free trade has its limits when politics come into play, according to Allen. “I’m not sure they are committed free traders,” he says of the administration. Allen likens today’s China-bashing to the criticism of Japan and its automakers in the 1980s.
The bra war is not the first time President Bush has shown protectionist tendencies. The administration incurred sharp criticism in March 2002 for taking steps to help U.S. steel companies that said they were being harmed by foreign imports. On Dec. 1, however, the Wall Street Journal reported that the administration was leaning towards ending the tariffs on imported steel following a ruling by the World Trade Organization (WTO) in October that the tariffs were illegal. China, Japan, the European Union and other nations could retaliate if the U.S. decides to leave the tariffs in place. A decision is expected this week.
Whatever Bush chooses to do, the broader issue of trade policy is not about to disappear. Trade was expected to be on the agenda during Chinese Premier Wen Jia-bao’s first visit to Washington on Dec. 7.
Higher Prices for Consumers
According to Linda Lim, professor of corporate strategy and international business atthe
Indeed, to proponents of free trade, the current friction between Beijing and Washington is puzzling because, when one looks at the big picture, trade between China and the United Statesis flourishing, and relations are, as far as most businesses are concerned, quite robust.
“U.S. major multinationals have been, in the last year or two, rapidly expanding their involvement in China, particularly in outsourcing activities and in direct investment for producing [goods] in China for export,” says Lim. “Definitely U.S. business believes things have improved dramatically since China joined the WTO in November 2001. Everyone believes that within China things are moving in the right direction – that is, towards more liberalization, efficiencies and so on. The Chinese government is viewed as being generally pro-business and pro-foreign business.”
Nonetheless, Lim adds, there are problems, such as the two-steps-forward, one-step-back nature of Chinese economic reform and China’s relations with the rest of the world. What’s more, China has moved sluggishly in living up to the free-market commitments it made as part of its admittance to the WTO. Another serious, longstanding controversy – China’s turning a blind eye to intellectual property rights – also remains unresolved.
All things considered, Lim says, American companies would give China a “B” as a business and investment partner, the same grade it would give to most other emerging economies. In her view, the reality of U.S. corporate relations with China is not as dire as rhetoric from inside the Beltway would suggest.
5,000 Years Old, Going on 25
Ming-Jer Chen, who teaches strategy and international management at the University of Virginia’s Darden School, likes to say that China is “5,000 years old but going on 25” because the Chinese leadership’s decision to open the country’s economy began only a quarter of a century ago. The pace of change can appear slow to outsiders, especially with respect to WTO reforms.
Chen, author of Inside Chinese Business: A Guide for Managers Worldwide, says that the United States and other countries “can never expect that China will change overnight. It’s always in the best interest of China’s government and people that they strike a balance between economic development and political stability. Often we accuse the Chinese of subsidizing manufacturers, but we should keep in mind that China is still a socialist country, not a capitalist country. I think we should be a little more patient in terms of how truly it can operate in the WTO framework. China has made a lot of progress. If we push too hard in terms of compliance, it may backfire.”
Chen agrees with Lim that it is odd that China has been made a “scapegoat” by some American politicians, because Chinese imports help consumers and big employers like Wal-Mart.
“A lot of China’s exports are [made by] U.S. companies invested in China,” according to Chen. “The U.S.-China trade deficit is $120 billion. Wal-Mart’s imports from China last year were $12 billion, so Wal-Mart contributed 10% of the U.S. trade deficit with China. We all want Wal-Mart to benefit customers, but that’s the paradox we’re facing. On the trade deficit, there’s no ground for the U.S. to accuse China, especially given what happened in the steel industry. But this is an election year. We’re going to see a lot of this.”
All of those interviewed by Knowledge@Wharton acknowledge that the development of China’s economy has cost, and will continue to cost, some American workers their jobs. But the nature of America’s economy has been changing ever since colonial-era cottage industries gave way to the assembly line and the manual laborer began to be supplanted by the knowledge worker.
The Three Ts
“The essence of trade is to allow countries to specialize,” states Erica L. Groshen, an economist at the Federal Reserve Bank of New York. “Just as trade between people allows people to specialize, trade between countries allows countries to specialize in the production of things in which they have comparative advantage. That’s where the gains in trade come from. We can’t all become heart surgeons. It’s better for a few people to do heart surgery rather than each of us to do heart surgery. It’s the same with making products.”
Groshen says the products and services in which the United States specializes change over time, depending on what she calls the “three Ts” – technology, taste and trade.
“We specialize in innovation,” Groshen explains. “We start new industries. We [create] new products. We have well-trained workers relative to the rest of the world. When an industry moves from being a new, innovative one to one that’s more mature, we lose our comparative advantage because we don’t need such innovative, skilled workers to make that product anymore. That’s when the rest of the world, which tends to have less-skilled, less-innovative workers, increases its comparative advantage and those jobs gradually move overseas. The more trade we have, the faster that happens. The more transaction costs go down and information costs go down, the more rapidly that can happen. That, in a funny way, is a sign of our success – that we’re continually exporting jobs. This has gone on through thick and thin, in good times and bad, for a century or more.”
In more recent years, the United States has lowered the barriers to trade, through both legal means and technological advances, so the pace of job exportation has accelerated. Despite the accompanying negative effects on U.S. workers and certain industries, China’s economic development helps other workers and industries.
“Even now we can see that some segments of America’s economy have benefited,” says Rawski, the Pitt economist. “China 20 years ago had little civil aviation; now it has a large and growing market and buys a lot of aircraft [from U.S. companies]. American farmers enjoy opportunities to sell in China and these will expand. American energy companies are deeply involved in a variety of projects in China. Already we see a wave of investment by U.S. auto manufacturers who are, of course, bringing their suppliers with them to China. And we now begin to see Chinese companies investing in the U.S.” Perhaps the best-known example is Haier, a producer of home appliances, which has purchased a building on Broadway in New York City.
One particular benefit from China’s entry into the WTO was to open the Chinese market to U.S. financial services companies, the most competitive and efficient firms of their kind in the world. American banks and mutual fund companies have already moved into the Japanese market and they are much better positioned to sell their products there than Japanese companies are, says Rawski. He anticipates similar opportunities for American companies in China.
Some observers worry about the size of the U.S. trade deficit with China – the fact that U.S. imports from China have grown more rapidly than exports to China. But Lim notes that it is important to keep the nature and extent of that deficit in context.
The United States has a global current account deficit – that is, an aggregate deficit with all countries in the world combined. It just happens that the biggest deficit of the various bilateral deficits is with China. America has a global current account for two reasons: the U.S. government’s large budget deficit and a paltry savings rate on the part of U.S. households. To finance its growth, America relies on large capital inflows from the rest of the world. Since the United States has a global current account deficit, it is importing more than it is exporting and, as a result, is earning less foreign exchange. The difference has to be made up by borrowing from abroad or selling assets to foreigners. The most recent statistics, for October, show that foreign investment into the United States has fallen dramatically. Because investors throughout the world have a low appetite for U.S. assets, it will be harder for the United States to borrow from abroad.
“It is not China’s fault that the U.S. has a global current account deficit,” Lim states. “The current account deficit in the U.S. is now 5% of U.S. GDP. This is an historic high. If this were the case in Brazil, capital markets would be panicked. The deficit with China happens to be the largest of all the bilateral deficits that the U.S. has. But, even so, imports from China account for just 1.5% percent of the total U.S. GDP. It’s very small.”
Lim adds that the loss of 2.7 million manufacturing jobs since President Bush took office has been due to slow economic growth and a dearth of business investment in the wake of the collapse of technology stocks in 2000 – not because of China stealing jobs.
“The U.S. economy is so huge that whenever you have something like high unemployment it has to be because of domestic factors, not trade,” she says. “Total imports from all countries in the world are only 15% of U.S. GDP. So, on a political level, there’s an attempt by the Bush administration to blame someone else for what is a failure of the U.S. domestic economy. This is not necessarily the administration’s fault; it could be the business cycle. The weak point in the Bush record is the large loss of employment, so it’s temping to blame foreigners rather than yourself. And it’s easy to point to China because of the trade deficit.”
U.S. Treasury Secretary John Snow has criticized China for not revaluing its currency. But Lim says politicians often misunderstand the issues involved in exchange-rate policy. “The Chinese currency is undervalued, but the reason is because it is linked to the dollar and the dollar has gone down. The Chinese have made no change to their exchange rate for nine years. They have reasons for doing that. In 1998 the U.S. praised China for pegging its currency to the dollar. The dollar is weak because the U.S. is consuming beyond its means. Demand for the currency is weak because people don’t want to buy it. This is the problem. The main reason is a structural, macroeconomic problem in the U.S.”
Marshall Meyer, a Wharton management professor who studies Chinese businesses and has spent much time in China, sympathizes with American workers who lose their jobs to overseas competition. But he says the best solution is not protectionism. Instead, the United States should educate workers to compete in an ever-changing world economy.
“In1960, a guy could work at an auto factory in Detroit and send his child to the University of Michigan,” says Meyer. “Those guys had skilled labor jobs and they were living the American dream. Today, the auto plants are in Tennessee and Alabama – and overseas. The opportunities are fewer. But in 1960, the U.S. had more than half the industrial capacity in the world; World War Two had obliterated everyone else’s. So, yes, the impact [from economic competitors like China] is enormous. But let’s face reality. There’s no way we are going to preserve America’s extremely high standard of living relative to the rest of the world. Ours will not necessarily go down, but the rest of the world will improve more rapidly than we do. The only way to preserve our high standard of living is to get real smart – to find the value added [in goods and services] and go for it. The relatively uneducated person is at a severe disadvantage in this game.”