China and the U.S. Trade Deficit

Bob Samuelson outlines the problems associated with the U.S.'s trade deficit with China:

China is already the world's third-largest trading nation and seems destined to become the largest. On its present course, it threatens to wreck the entire post-World War II trading system. Constructed largely by the United States, that system has flourished because its benefits are widely shared. Since 1950, global trade has expanded by a factor of 25. By contrast, China's trade is mercantilist: It's designed to benefit China even if it harms its trading partners.

There's a huge gap in philosophy. By accident or design, China has embraced export-led economic growth. The centerpiece is a wildly undervalued exchange rate. Economist Morris Goldstein of the Peterson Institute thinks the yuan is 40 percent cheaper than it should be. The resulting competitive advantage props up exports, production and jobs. Since 2001, China's surplus on its current account -- the broadest measure of its trade flows -- has jumped from $17 billion to $239 billion. As a share of China's GDP, it has zoomed from 1.3 to 9.1 percent...

Despite popular impressions, China's trade offensive hasn't yet seriously harmed most other economies. For example, America's current account deficit (to which Chinese imports contribute) was $857 billion last year, up from $389 billion in 2001. Still, that hasn't stymied job creation; the U.S. unemployment rate is 4.5 percent. And world economic growth has accelerated.

Even Chinese officials favor higher local demand. But either they can't or won't stimulate it. Personal consumption spending is a meager 38 percent of GDP; that's half the U.S. rate of 70 percent. The Chinese save at astonishingly high levels, partly because they're scared of emergencies. The social safety net is skimpy. Health insurance is modest: Out-of-pocket spending covers half of medical costs, reports economist Nicholas Lardy of the Peterson Institute. There's no universal Social Security, and only 17 percent of workers have pensions. A mere 14 percent are covered by unemployment insurance.

It is not "protectionist" (I am a long-standing free-trader) to complain about policies that are predatory; China's are just that. The logic of free trade is that comparative advantage ultimately benefits everyone. Countries specialize in what they do best. Production and living standards rise. But the logic does not allow for one country's trade systematically to depress its trading partners' production and employment. Down that path lie resentment and political backlash.

Everyone complains about America's trade deficits, but they actually symbolize global leadership. Access to the U.S. market has promoted trade by enabling other countries to export. But the deficits cannot grow indefinitely. Imagine now a trading system whose largest member seems on accumulating permanently large surpluses. Nor, it might be added, are surpluses ultimately in China's interests. They drain too much of its production from its citizens and contribute to growing domestic economic inequality. What everyone needs is more balanced Chinese economic growth, less dependent on exports.

Given the immense stakes -- literally the future of the global trading system -- the Bush administration has been too timid in pushing China to change. The Treasury Department won't even declare China guilty of currency manipulation. No doubt doing so would irritate the Chinese. But avoidance is no solution; the longer these problems fester, the more intractable and destructive they will become.

On the first point, that China is undermining the world trading system that the United States helped create. Well, the United States is not using the mechanisms that it created to resolve illegal trading practices. The purpose of the WTO dispute settlement mechanism is to bring countries to negotiate, and if all else fails, to litigate to prevent illegal practices from continuing. Samuelson claims that China is wrecking the system. I assume that he means China is undermining the system by subsidizing its currency. But currency manipulation is not against WTO rules, and secondly, undervaluing one's currency is akin to an export subsidy AND an import tariff. The U.S. should continue to take the Chinese to court in other areas, however, where China is in violation of trade rules.

On his reference to the IIE study holding that China's currency is overvalued by as much as 40 percent. Even if China revalues, the U.S.'s trade deficit with the world will remain unchanged. Basically, Samuelson is worried about deficits and thinks that revaluing the Yuan will solve the problem. But it won't. It COULD change the composition of the U.S. trade deficit.