Better Ways to Deal With China

http://www.nytimes.com/2012/10/24/business/better-ways-to-deal-with-china.html

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Less than a year into a new administration, the nation’s trade deficit is soaring. Manufacturers are complaining bitterly that an overvalued dollar is destroying the economy, driving businesses abroad. Congress is bubbling with proposals to punish countries that are flooding the United States with cheaper exports.

The gimlet-eyed realists in the new administration decide it is time to get tough, and it works. Within four years, the currencies of our main trading partners have risen sharply against the dollar; the exchange rate of our main Asian rival has jumped by a third. The trade deficit starts to recede. America — undisputed leader of the free world — gets to carve one more notch in its belt.

This is the type of success Mitt Romney hoped to conjure up during the foreign policy debate on Monday night when he promised to get tough on China from “Day 1,” designating China a currency manipulator and opening the door for trade sanctions. It is also the image President Obama wanted to convey when he countered that he has been twice as tough on China as his predecessor, George W. Bush.

The vignette, however, is old.

It comes from Ronald Reagan’s second term, when Japan rather than China inspired fears of American decline. Treasury Secretary James A. Baker III, a k a the Velvet Hammer, summoned the finance ministers of Japan, West Germany, Britain and France to the White and Gold Room of the Plaza Hotel in New York on Sept. 22, 1985, to devise an agreement to weaken the dollar.

We also got tough with our trading partners in 1971, when the Nixon administration imposed a 10 percent surcharge on imports to force them — Japan, above all — to revalue their currencies and help right an American trade balance that was sliding into deficit for the first time since the 19th century.

Tempting as it is, that approach to economic policy is unlikely to be very effective today. In the 1970s and ’80s, the club of industrial democracies was bound by the common Soviet threat. Japan, protected by the American nuclear umbrella, would do what the United States wanted. Today the Soviet Union is gone. China may not be as powerful as the United States, but it is powerful enough to hit back.

More important, trying to push China around like a bulked-up version of 1980s Japan does not fit with our national interests. In fact, it puts at risk a central, long-term American objective: drawing China into the club of prosperous, rule-bound and democratic nations.

As the economists Daron Acemoglu and James Robinson warn in their new book, “Why Nations Fail,” China’s autocratic government will end up suppressing prosperity, stifling innovation as it clings to power and breeding instability as factions fight for the spoils of growth. Helping steer China away from such an unstable, dangerous course is a core American goal.

China’s economy is slowing sharply. Political turmoil is swirling just weeks before only the second peaceful transition of power in the history of the Chinese Communist Party. Loud, unilateral American toughness at this stage is unlikely to help. It may prompt a reaction against the more outward-looking, reform-minded constituencies, strengthening conservative forces that are unwilling to cede any political control.

And for all this risk, getting tough is unlikely to deliver much.

The Chinese currency is the wrong target. Of course China has been manipulating its currency for years, buying mountains of dollars to keep the renminbi cheap and give its exporters a leg up. But Beijing appears ready to correct course.

Factoring in China’s fast inflation, which makes its exports more expensive, the real value of the renminbi has risen at least 15 percent against the dollar since mid-2010. Beijing has curbed its dollar hoarding. And its broad trade surplus is falling fast: down to 2.3 percent of its economic output this year from more than 10 percent in 2007.

China’s trade surplus with the United States is in part an illusion, because exports assembled in China from imported components are counted as 100 percent Chinese. Yuqing Xing, an economist at the National Graduate Institute for Policy Studies in Tokyo, estimates that China contributed only 3 percent to the value of its exports of iPhones and laptops in 2009.

Chinese labor costs accounted for only $6.50 of the $178.96 wholesale cost of an iPhone 3G exported by China, according to a study by Mr. Xing and Neal Detert. Japanese components accounted for $60.60, German parts for $30.15, Korean components for $22.96 and American parts for $10.75. The numbers are rough. Some of the parts may have been made in China. Still, counting the entire $178.96 as a Chinese export vastly overstates its role.

Even if we conclude that currency manipulation alone is causing our bilateral trade deficit — a highly unlikely proposition — we can’t blame it on China. “We have an Asian trade deficit,” said Clyde Prestowitz, a former trade adviser to the Reagan administration. “If we were serious, we would say there are a number of countries manipulating their currency and distorting the world economy.”

Joseph E. Gagnon, a former Federal Reserve official at the Peterson Institute for International Economics, says 20 countries actively depress their currencies to bolster their exports, including Japan, Switzerland, Taiwan and Korea. Many may be following China’s lead — trying to stay competitive with the renminbi. Still, if we’re going to get tough on currency manipulators, we might want to go after the lot.

China will continue to pose significant economic challenges for the United States in coming years. The cheap currency may recede as an issue. But there is China’s theft of foreign intellectual property, its raft of hidden subsidies to domestic companies and its strong-arming of foreign companies to hand over industrial secrets to domestic joint venture partners, among other issues.

Still, getting tough is not the best way to address them.

In the State of the Union address this year, President Obama said he had saved more than 1,000 jobs in the tire industry by imposing tariffs to stop a surge of imports from China. Gary Hufbauer, an economist at the Peterson Institute who worked in the administrations of Gerald Ford and Jimmy Carter, estimated that each job saved cost Americans at least $900,000 in more expensive tires, reducing spending on other goods.

After all is said and done, Mr. Hufbauer concluded, the policy cost the economy 2,531 jobs. And that doesn’t even count the effect of China’s retaliation: antidumping duties on chicken parts that led to $1 billion in lost sales and reduced employment further.

There are tools to deal with China without setting off a trade war and undermining the national interest. Many economists have suggested changing the rules of the World Trade Organization to allow retaliation against currency manipulators. The European Union would probably support such changes. Interested countries could start the process by forming a voluntary nonmanipulation club and use carrots and sticks — say, a tax on China’s Treasury Bond purchases — to get reluctant nations to join.

A multilateral approach, with tough talk in private, is also more likely to succeed against other egregious policies. President Obama may talk tough on China on the campaign trail. But his policy of engagement recognizes this. His administration’s strategy of taking China’s unfair practices to the World Trade Organization, where it has filed three cases since August, is likely to be more productive than unilateral action lacking the legitimacy of international law.

None of this has the gritty ring of a public proclamation to get tough on the cheaters across the Pacific. But all-American grit is unlikely to deliver the results that we need. After all, we still run an $80 billion deficit with Japan.

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