China trade deficit travail

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The rapidly rising U.S. trade deficit with China is quickly becoming a political issue. Many members of Congress are warning that China needs to take action, such as raising its exchange rate, to deal with this problem before it leads to protectionist legislation. A closer examination of the Chinese trade problem, however, suggests there is less here than meets the eye.

In a very short time, Chinese goods have become the largest component of America's trade deficit. From virtually nothing in the 1980s, our trade deficit with China jumped to $103 billion last year. We exported just $22 billion worth of goods to China while importing $125 billion. By contrast, our trade deficit with Japan last year was 30 percent lower than that with China.

It is important to put these numbers in perspective. Although China represented 22 percent of the U.S. trade deficit last year, that is down from 27 percent in 1997. Also, China runs a trade deficit with the rest of the world. In 2001, China's total surplus was $33 billion while its surplus with the United States was $83 billion. Among those countries running surpluses with China are Taiwan ($25 billion) and Korea ($11 billion).

This suggests China is not running a trade policy aimed at subsidizing exports or keeping out imports; otherwise, it would be running a surplus with everyone. As a recent Federal Reserve Bank of Cleveland study concluded, "China has the largest surplus of any country in its bilateral trade with the United States, not because its market is closed but largely because it has emerged as a major global production base for labor-intensive manufactured goods."

The Fed study goes on to note that most of our imports from China have not displaced domestic manufacturing but rather have displaced imports from other Asian countries. For example, it notes that our imports of footwear from China previously came from Taiwan and Korea, and many of the toys and games we import from China were imported from Hong Kong in the past.

Further evidence Chinese goods are not replacing domestic production comes from the foreign direct investment data published by the Commerce Department. The latest figures in the July Survey of Current Business show China is far from the magnet for U.S. investment many imagine it to be. At the end of 2002, U.S. companies had just $10.3 billion invested in China, a decline of $1 billion from the year before. By contrast, American companies had $255 billion invested in Britain, $152 billion in Canada and $145 billion in the Netherlands. Looking just at foreign direct investment in 2002, 55 percent went to Europe, and only 26 percent to all of Asia.

What these data demonstrate is that U.S. companies are not just looking for cheap labor. If that were the case, the last place they would invest would be Europe, where many workers make more than their American counterparts. According to the Bureau of Labor Statistics, manufacturing labor costs are 17 percent higher in Germany than here. In those cases where labor costs are lower, the magnitude is small. Generally speaking, foreign investment is driven more by a desire to gain access to markets than a desire to cut production costs.

Another point worth noting about the Chinese trade surplus is that China sends much of it right back to us by buying U.S. Treasury securities. At the end of June, China owned $122 billion of such securities -- an increase of $55 billion in the last three years. China is now the third-largest foreign holder of Treasury bonds and will probably be the second by year's end. (Japan is far and away the largest at $442 billion -- something else worth thinking about.) In effect, our trade deficit with China is helping finance our budget deficit, keeping interest rates here lower than they otherwise would be.

Nevertheless, there are many who believe China is practicing de facto protectionism by manipulating its exchange rate. If a nation's exchange rate is undervalued, it will tend to make its exports cheaper in terms of foreign currencies and imports more expensive, thereby stimulating exports and hindering imports. Some experts believe the Chinese government is holding the yuan (the Chinese currency) as much as 40 percent below what its free-market value would be.

The problem with this logic is that the yuan is pegged to the dollar and has been for some years. It goes up and down as the value of the dollar does. In the view of most economists, such as Stephen Roach of Morgan Stanley, China is not competing on the basis of an undervalued currency but "mainly in terms of labor costs, technology, quality control, infrastructure and an unwavering commitment to reform."

Bruce Bartlett is senior fellow with the National Center for Policy Analysis and a nationally syndicated columnist.