The US has run a trade deficit with China since 1973. The deficit increased from $10 billion in 1990 to $266 billion in 2008. It dropped to $227 billion in 2009, and then grew to $295 billion in 2011 but dropped again in 2012 to $262 billion. The Sino-US trade deficit consistently accounts for more than 40% of the US’ overall deficit in its global trade.
Some in the US argue that this large deficit with China is caused by the competitive advantages China gains from practices such as keeping its currency artificially depreciated, having lax environmental and health and safety legislation, poorly protecting intellectual property rights, not comprehensively implementing WTO obligations, and widely employing industrial policies and discriminatory government procurement practices which work to subsidize and protect domestic Chinese firms at the expense of their foreign competitors. Critics argue that these practices have in turn caused the US to unfairly lose manufacturing and other jobs to China.
Others have argued that Chinese economic policies, which have enabled China’s GDP to grow 9% annually over the last two decades, have provided many advantages to the United States. For instance, China’s rapid economic growth has generated significant demand for US exports. For the last 10 years, China has been the US’ fastest growing export market. In the future, this market is expected to further expand as China’s domestic demand develops, as the living standards of its citizens improve, and as a sizable Chinese middle class emerges.
US consumers have also benefited from cheap Chinese imports, both because they increase US consumer purchasing power, and because they act to keep inflation low. US firms have profited from China’s competitive workforce, either by using China as a low-cost assembler of its manufacturing components or as a source of inexpensive components to be assembled in the United States. As importantly, by purchasing US treasury securities – nearly $1.2 trillion as of September 2012 – China helps keep US interest rates low, which in turn spurs domestic US economic activity.
Since the financial crisis of 2008, trade relations between the US and China have come under greater scrutiny by government and business leaders from both countries. Some members of the US Congress have recently ratcheted up their complaints about what they consider to be China’s distorted trade policies, given the US’s persistently slow US GDP growth and high unemployment. This trade friction is likely to intensify as the current sovereign debt crisis faced by Western countries places a new spotlight on US debt levels.
The US exported $90 billion of merchandise to China in 2012, down from $104 billion in 2011 but still more than 30% higher than 2009 levels. US exports to China account for around 7% of total US exports, up from to 2.1% in 2000. The largest exports to China included oilseeds and grains, waste and scrap, semiconductors and electronic components, aircraft and parts, and resins and synthetic rubber and fibers. It is expected that US exports to China should continue to grow rapidly in the future. This export growth will be driven by factors such as the continuing modernization of Chinese infrastructure, by increasing domestic demand from its growing numbers of middle-class and affluent consumers, by the growth of its transportation industries, particularly its rising need for airplanes, trucks and cars, and by its increased imports of food products.
Yet, despite the success the US has made in increasing exports to China over the last decade, Chinese exports to the US still dwarf US sales to China. In 2012 China’s exports to the US were worth $351 billion, which was down from $399 billion from the previous year. The top 2010 Chinese exports to the US were apparel, manufactured goods such as toys and games, computers and communications equipment and parts, and audio and video equipment. The mix of Chinese exports to the US is shifting. Throughout the 1980s and 1990s, the majority of US imports from China were low-value, labor-intensive products such as textiles and toys. Increasingly, however, more of US imports from China are comprised of advanced technology products, reflecting China’s growing international competitiveness in the assembly and manufacture of high-technology.
One of the principal drivers of the US trade deficit with China is the worldwide increase in global production sharing, from which China has benefited enormously. Many products that used to be entirely made in such places as Japan, Taiwan and Hong Kong, are now being made or assembled in China as those countries have shifted all or parts of their production to China in order to take advantage of its low-cost labor. For instance, the US International Trade Commission estimated that in 2002, 99% of computer exports to the US from China were sold by foreign firms manufacturing in China. Taiwan, a world leader in information technology manufacturing, now produces over 90% of its information hardware equipment in China. Similarly, many US technology companies outsource their manufacturing to Taiwan, which in turn outsources this production to its facilities in China. Yet, these exports, even if they are commissioned by US firms, are credited against China when calculating the US trade deficit as China is the place from which the products were shipped to the US. To illustrate this, it is worth considering that while US imports of computer equipment from China rose 620.5% between 2000 and 2010, the total value of US imports of computers worldwide rose only 41.9%.
Similarly, China now has more than 40% of all international processing or assembling trade. The iPod, for example, is assembled in China by the Taiwanese firm Foxconn, from parts produced globally. A 2005 study by the University of California estimated that it costs approximately $144 to make each iPod unit, yet only about $4 of the total cost is generated by the Chinese workers who assemble it. Yet, when China ships the iPod to the US, it increases the Sino-US trade deficit by the full $144 cost of the unit, not by the $4 of value that China earned assembling the different components. In similar fashion, the iPhone trade has increased the US-Sino 2009 deficit by $1.9 billion. Yet, if the trade were measured through value added in China, the US trade deficit would have decreased by $48 million. Likewise, each unit of the iPad 2 increases the deficit by approximately $250. On the day of its release, the iPad 2 was estimated to have contributed $130 million to the Sino-US trade shortfall.
As shown with the Apple example, international trade data struggles to accurately account for component processing. In its trade numbers, China is credited with the full value of the finished exported goods, regardless of the origin of the component parts. For example, if Japan supplies the original components to China and then China does nothing but assembles the components and then ships the finished product to the US, Japan’s US trade balance is unaffected, but the US’s trade deficit with China increases by the full cost of the finished good. This distorts trade data, giving a skewed impression of the total value of the goods originating from China. As China’s trade has increasingly shifted away from the production of textiles and other primary products to the manufacture and assembly of technology goods, this skewing has increased.
The services trade is also equally difficult to quantify. Most trade data does not take account of the value added to a product by services, such as IT, financial, or management consultancy services. As the largest supplier of these services worldwide, the US generates income by effectively employing its advantage of human capital. The incomplete accounting of these services in world trade data means that the overall US deficit appears larger than it is in actuality.
Another important driver of the trade imbalance between the US and China is Beijing’s pegging of the RMB to the dollar at what is deemed by many to be a substantially discounted rate. While many agree that the RMB is undervalued, few concur on the actual level of distortion with estimates ranging from 15% to as much as 50%. The depreciated currency increases the competitiveness of Chinese exports, leading many US companies to import from China over domestic or other international suppliers. China’s currency has not always been undervalued. In the early 1980s, for instance, it was greatly overvalued, with 1.5 RMB per USD, a rate set to allow China more easily import the goods it needed to develop its economy. There have been numerous revaluations of the RMB-dollar exchange rate since the 1980s. Between 1994 and 2005, the rate remained stable at around 8.3 RMB per USD. Though generally resistant to international pressure, particularly regarding key domestic interests, the CCP has since allowed the RMB to appreciate, albeit very gradually. The most significant appreciation occurred between 2005 and 2008 when the rate shifted from 8.27 RMB to 6.81 RMB per USD, an appreciation in value of the Chinese currency of almost 18%. However, it remained at or around that rate for another two years, before a further gradual appreciation was allowed to begin in 2010. By June 2012, it was valued at 6.36 RMB to the USD. China is able to maintain this low rate of exchange through vast purchases of US treasuries, which helps keep the dollar strong; as of November 2011, China held approximately $1.3 trillion dollars in reserves, equating to around 40% of its enormous foreign reserves.
This implicit subsidy to Chinese exporters has meant that US manufacturers have struggled to compete against Chinese products, causing US manufacturing industries to suffer and US unemployment to increase. Some estimates have put the number of additional US unemployed because of China’s devalued exchange rate at 2.4 million between the years of 2001 and 2008. Yet, what is often forgotten in debates on US unemployment figures is that the average US citizen has benefited from cheaper consumer products and, consequently, a greater disposable income. Recent estimates suggest that the average American household is $625 per year better off as a result of low-cost Chinese trade.
Beijing insists that its foreign exchange policy is vital to domestic economic security; the stability of its society and its monopoly on power is very much dependent on its ability to provide economic prosperity to its people. Additionally, an appreciation in the RMB also means that its US dollar holdings will buy less in its own currency. For example, an appreciation of the RMB by 41% would result in a value of $672 billion effectively being wiped off China’s US securities’ holdings in terms of what those holdings would be able to purchase if converted into its domestic currency.
Some US analysts contend that China’s holdings of US debt give it a potentially powerful tool which it can use as leverage against the United States. Yet, China’s economic reliance on the US economy as an export market and its substantial holdings of US securities means that any effort to sell large volumes of dollars would likely hurt China as much as it would damage the US. A large sell-off of dollars would cause the currency to sharply depreciate against global currencies, diminishing the value of China’s remaining dollar holdings. Additionally, as long as China continues to pursue a depreciated currency policy, it has no choice but to purchase US dollars, thus making the likelihood of a large Chinese sell-off of the currency highly unlikely.
China has its own concerns about its large US dollar holdings. It fears that high levels of US debt, and the potential implementation of expansionary monetary policies by the US government could spark inflation in the United States which would result in a sharp depreciation of the dollar. To offset this risk, China has argued for the creation of an alternative reserve currency, such as through the International Monetary Fund’s special drawing rights system. Yet, most expect that the creation of an alternative reserve currency is not likely not to occur in the near future. In the absence of such a solution, China has sought to diversify its foreign currency reserves, notably through purchases of Japanese yen and Euros.
China became a WTO member in December 2001. US policymakers supported China’s accession as they believed WTO membership would spur deeper market reforms, encourage the rule of law, diminish the government’s role within the Chinese economy, further assimilate China into the world economy, and enable the United States to use the WTO dispute resolution mechanism to resolve trade disputes between the two countries. In the first years after China’s accession to the WTO, it made great strides in opening its economy to both trade and FDI. Its ratio of imports to GDP – a common measure of how open an economy is – has now surpassed 30%, which is twice the level of the United States and three times that of Japan.
Yet, by 2008, government and business officials had begun to note that Chinese efforts to liberalize its markets appeared to have slowed. With the tougher global economic environment many argue that China relies more on state intervention in markets to gain China a competitive advantage. This has caused some friction between the two within the WTO. As of January 2013, the United States has brought 16 trade complaints against China whereas China has brought 8 cases against the US. Of these 24 disputes, 5 were raised in 2012 making it the most fractious year to date.
A key area of WTO complaints by the US has been the violation of intellectual property rights within China, and the US has brought two cases against China over this issue. The US International Trade Commission estimated that US firms with significant intellectual property interests lost $48.2 billion in sales, royalties and license fees in 2009 because of international property rights violations in China. The International Intellectual Property Alliance estimated that business software piracy in China alone cost US forms $3.4 billion in lost trade in 2009. However, these figures have been questioned by some economists who point out that the calculations are based on an assumption that genuine products would be purchased if all counterfeit goods were eliminated. Given that the price in China for a counterfeit DVD is usually around $1.50, compared with in excess of $12 for an authorized version, it is highly unlikely that an elimination of counterfeit products would have no impact on the overall sales figures of these products. It may not be possible to give a wholly accurate figure for the losses that the widespread IPR-infringements cause. US critics feel that, even when IPR enforcement is in place, fines and punishments for IPR infringements are often not sufficiently punitive to deter Chinese companies from piracy. Some estimates suggest that between 15% and 20% of all products made in China are counterfeit, equal to about 8% of China’s total annual domestic product. Under pressure from the US, in late 2010, China launched a six month campaign against IPR abuse and counterfeit goods.
Although it is understandable that Beijing is somewhat protectionist in its exchange rate policy, a revaluation of the RMB is essential if current imbalances are to be eased. China cannot continue to purchase US securities indefinitely – indeed it has already shown that would prefer to diversify away from its overwhelming reliance on the dollar – and the US cannot continue to get deeper and deeper into debt to foreign creditors. To resolve the situation, China needs to stimulate domestic consumption and allow its exchange rate to appreciate. A key to increasing Chinese domestic consumption will be shoring up its healthcare and pension systems that were largely dismantled when the Chinese privatized large sections of its state-owned industries. A stronger currency will decrease the international competitiveness of Chinese products, but will reduce pressure on the US, China’s largest trading partner. This will lead to greater global economic stability, which is ultimately in China’s interests. Thus while China’s manipulation of the RMB is expected to continue, in the long-run, a slow appreciation of the RMB would be expected as a more balanced trade environment is in the interests of both China and the US. In fact, between September 2010 and December 2012, China allowed the RMB to appreciate 7.4% against the dollar. Though China needs to take action on this issue, 2012 Presidential Candidate Mitt Romney’s vow to declare China a “currency manipulator” on his first day in office had he win the election, is not the sort of tactic that should be employed. Such a move would have made it politically more difficult for the Chinese to act in the way that the US would like them to do.
At the same time, in order to reduce its trade deficit, the US needs to stimulate domestic manufacturing and become more internationally competitive. Investment in infrastructure, education and the creation of a national industrial policy with taxes and other incentives to spur the development of strategic industries would enhance the ability of the US to continue to design and produce products that would be in demand internationally. The challenge for the US is that the increasingly divergent views of its two main political parties has made it progressively more difficult for it to take the necessary legislative steps to invest in economic competitiveness.
While both the US and China have benefited substantially through closer economic ties, the trade imbalance has increasingly become a political concern. To date, no concrete plan has been formulated to bring the deficit back into balance. However, some steps have been taken to increase economic cooperation between the two nations. The annual US-China Strategic and Economic Dialogue (S&ED), established in April 2009, is intended as a forum to discuss “long-term strategic challenges”. However, in the 2011 session there was no consensus as to the future of the trade imbalance between the two countries and it received mixed reviews from American business leaders and government officials.
The issue of the amount of US sovereign debt held by China is of huge political significance. On a positive note, China’s extension of credit has helped decrease US inflation and, hence, to maintain domestic economic stability. Yet US indebtedness to China is seen by many American thinkers to be a real risk; China and the US only formally resumed diplomatic relations in 1979, having been at ideological loggerheads since the founding of the PRC in 1949. Even today, the US and China disagree on many international issues. There are numerous domestic political ramifications of your largest creditor also being traditionally perceived as an ideological competitor. The amount of US debt held by China means that it would be incredibly difficult to offload all at once, and would trigger a huge devaluation in its remaining holdings. Such a situation is unlikely and would be particularly unwise, but shows the extent of the economic power China holds over the US. Yet China is increasingly using that economic power it holds over the US as leverage over contentious political issues, such as Taiwan and its human rights record. This trend should be expected to continue.
The reality is that the fates of the economies of China and the US are closely entwined, each reliant on the health of the other. China has been recording a substantial trade surplus with the US over the past 20 years and there has been a considerable decline in the US manufacturing sector. We have seen, however, that China’s trade surplus with the US is more a product of the system of trade-data collection than of a mercantilist strategy to undermine US manufacturers. The imbalance is, of course, a concern for both countries, but it is in neither country’s interests for the other’s economy to fail. The deficit must be addressed through mutual cooperation and dialogue in order for both countries to prosper and will, in turn, lead to a more balanced and secure global economy.