China and East Asia play by different rules
By Clyde Prestowitz
To show it means business with Beijing on trade, the Bush administration recently threatened duties on imports of some Chinese paper and formally charged China with violation of World Trade Organization rules. The reaction has ranged from euphoric predictions of a reduction of the Himalayan U.S. trade deficit to warnings of a disastrous trade war. In fact, neither will occur because the White House measures are not new, not tough and not relevant.
A U.S. trade negotiator in the Reagan administration, I am familiar with this old ritual. In the background is the U.S. trade deficit that is setting new records and is especially large with a particular country ? yesterday Japan, today China. Imports from these countries and elsewhere are flooding the American market, causing complaints of ?unfair trade? from U.S. companies and workers losing business and jobs. The administration ? Republican or Democratic, makes no difference ? emphasizes the benefits of ?free trade? and the dangers of ?protectionism? and pledges to ?open? the offending foreign market to competitive U.S. exports while also monitoring for any violation of trade rules. A high-level bilateral dialogue on trade, currency and broader economic issues is launched with the big surplus country.
The Americans urge their partner to abandon currency manipulation and other strategic practices and to further ?liberalize? markets for the good of their own economy. The talks go nowhere as the partner country blames the problems on lazy, incompetent American companies and U.S. policies that result in excess consumption and negative savings.
Congress and the administration then do a dance within the dance. Some congress persons threaten trade-restrictive legislation if the trading partner doesn't shape up. The administration publicly condemns such ?protectionist? talk but privately urges Congress to keep it up as a way of providing leverage to U.S. negotiators who warn their dialogue partners of possible dire acts by the ?crazies? in the U.S. Congress if the foreign market is not opened satisfactorily.
Some congressional members, however, mean it, and there is usually some just completed Free Trade Agreement that needs ratification by Congress. With the high-level dialogue going nowhere, the administration du jour announces some formal trade complaint or the imposition of some countervailing duty to stop dumping or some other infraction. This sounds tough and the trading partner obligingly howls as if in pain and hints at possible trade war. The items involved, however, are a trivial part of overall bilateral trade and there is no possibility of trade war because that's the last thing either side wants. The real objective of the whole exercise is to buy time and get the trade agreement passed by Congress while ?market forces? hopefully operate to correct the effects of the imbalances: closed factories, and lost jobs.
Thus are the recent White House statements and actions not new. Nor are the Chinese necessarily being unfair, and even if they were the proposed measures will amount to no more than pin pricks in the overall context. So it is misleading to talk about being tough. Most important, however, is the fact that whatever is done will in no way change the situation that increasingly threatens the long-term health of the U.S., Chinese and global economies. The reason is that the whole process is based on false premises and a profound error of conventional economic wisdom. The trade negotiators are busy discussing the last war even as weapons of mass destruction are about to explode.
U.S. negotiators always assume that WTO-member countries are playing the same free-trade game as the United States. That game focuses on maximizing consumer welfare, it allows the dollar's value to float in response to currency markets, seeks market-based results as ends in themselves, has Americans saving nothing while they consume more than they produce, and preaches specialization of production based on what a country's resources enable it to do best while trading for the rest. As one top U.S. economist has said; ?potato chips, computer chips. What's the difference? They're all chips.?
In fact, this is not at all the game China, Japan, Korea, Ireland, Israel, Taiwan and many others are playing. Their focus is production and technological ?catch-up,? not consumption. They compel their citizens to save at very high levels, pursue export-led growth, foster development of target industries such as semiconductors, aim to accumulate large trade surpluses as a matter of national security, use markets as tools rather than as ends in themselves, and strive to change their resource endowment in order to achieve broader ranges of production and targeted economic structures. They see a big difference between computer chips and potato chips.
While Americans often see this kind of ?strategic trade? as unfair, it is important to emphasize that this is the Asian miracle formula and that it has long been accepted as fitting within the technical rules of the WTO. So it is not always clear that there is unfairness. But for sure the two games are quite different. In effect, the Americans are playing soccer while the others are playing football. None of the teams is playing its game unfairly. But the football players have helmets and pads and love to hit each other while the soccer players are nearly naked and try to avoid contact.
Not only is the same-game premise false. So is another set of economic premises. Conventional U.S. trade doctrine is based on the theoretical assumption that most markets are perfectly competitive, that economies of scale are non-existent or largely unimportant, that labor, capital and technology don't easily cross borders, that market entry and exit are essentially costless, and that currency values are not strategically managed. On the basis of these assumptions, conventional economic wisdom holds that if countries subsidize their industries, engage in dumping, or protect their home markets, they are only hurting themselves. The proper reaction is thus deemed to be to avoid retaliation in favor of persuading them to open their markets.
Most of these assumptions obviously are wrong. Recent work by former IBM chief scientist Ralph Gomory and Nobel Prize-winning economist William Baumol has demonstrated that in today's real world, the industrial and currency management and other market-distorting policies of an American trading partner can be very damaging to the long-term health of the American economy as well as to the world economy. Economies of scale, rapid technological change and instant mobility of technology, capital and, increasingly, even labor change the situation dramatically.
As a result, the combination of the soccer/football games in the current mode of globalization is moving American providers of tradable goods and services off-shore. Manufacturing as a percent of U.S. gross domestic product has fallen from about 20 percent to 11 percent of GDP in the past 15 years. Recently, high-tech services and R&D have also begun to move abroad. This could be harmful to long-term U.S. productivity. It is also helping to create an unprecedented trade deficit that has now reached 7 percent of the American economy's total annual output of goods and services, the U.S. gross domestic product.
At the same time, China and the other countries of East Asia have accumulated nearly $3 trillion in hard-currency reserves. The United States has become the world's biggest debtor nation and the health of its economy is dependent on constant and growing lending from Asia to finance the trade deficit. Both sides are locked in an unsustainable embrace. Americans cannot indefinitely spend more than they earn and Asia will not be willing indefinitely to accumulate American paper. Both former Federal Reserve Chairman Paul Volcker and Warren Buffett have warned of the high risk of a global crisis that could make the Great Depression look like child's play. If and when the crisis comes, China and the United States and many others would all suffer damage. One can argue about who would suffer the most, but the real issue is how to prevent the crisis.
For starters, currency management by East Asia (not just China) has to stop. The dollar will have to be devalued by 30-50 percent against most of the East Asian currencies. Ideally that could be achieved through negotiation, but if not, Washington might consider seeking action from the WTO to identify chronic currency undervaluation as an illegal export subsidy or as a nullification and impairment of tariff concessions.
By the same token, the subsidies and tax incentives widely used in both Asia and Europe to entice companies to invest in particular countries must be disciplined along the lines that already exist for export subsidies, and Washington could request similar action by the WTO. Cartels and buy-national policies are common in much of the world and U.S. negotiators should also seek to have the WTO classify them as illegal and subject to sanction.
If the United States cannot obtain adequate action from the WTO and the International Monetary Fund, it might consider declaring a balance of payments emergency under WTO rules. This would enable U.S. authorities to impose temporary measures aimed at achieving adjustment in the trade deficit.
At the same time, Washington should undertake to balance the federal budget, match foreign investment incentives, and reverse American incentives for saving and consumption by such steps as a curtailment of the tax deduction for interest paid on home equity loans and the introduction of a reverse income tax that would progressively tax consumption instead of income.
This won't be easy but if we don't do it now, the markets will do it for us later in what could be the biggest crash of all time.
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