Smith Faculty Opinion Article	November 28, 2006
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

Answering Chinese Mercantilism is Not Protectionism,
Its Merely Self Defense

Democrats soon to control Congress are frightening large multinational corporations with promises to do something about the U.S. international trade deficit. Prominent newspapers are publishing commentaries warning against the perils of protectionism. As the author of several tracts extolling the virtues of free trade, I find these reactions wrongheaded and counterproductive.

Free trade is the logical international extension of exchange among individuals. Comparative advantage permits each country to make more of what it does best, import the rest, and ratchet up living standards.

U.S. export industries, such as industrial machinery and finance, achieve more than10 percent greater value added per worker than import-competing industries, such as consumer electronics and apparel. By exporting $1500 billion each year and buying a like amount of imports, the United States saves enough labor to raise GDP about $160 billion more than $1000 for each American employed.

Sadly, the United States imports $810 million more than it exports. The workers released from making those additional imports go not into jobs in export industries but into activities that do not compete in trade, such as restaurants and retailing, where labor productivity is about 50 percent lower. This redeployment of labor slices about $400 billion off U.S. GDP.

It is easy to see how large trade deficits can overwhelm the gains from trade and undermine public support for the U.S. free trade policies.

The federal budget deficit and imported oil contribute importantly to the trade deficit. However, the $250 billion federal deficit could not possibly cause an $810 billion trade deficit, and the $275 billion trade gap with China now exceeds net petroleum imports.

Imports outnumber exports with China six to one. That is remarkable, because China is the fastest growing market on the planet for what Americans make best capital goods, technology products, financial services, and the like.

Many U.S. firms cannot export to China or compete with Chinese products in the United States, because China maintains an artificially undervalued currency, imposes high tariffs on imports, offers subsidies to locate production in China, limits what foreign investors may buy outside China, and enforces other industrial policies to suppress imports and boost exports.

Less than half of Chinas price advantage is created by inexpensive labor. The rest, quite plainly, comes from chiseling and cheating on the rules.

Each year, China dumps enough yuan into foreign exchange markets to purchase more than $200 billion U.S. dollars, other hard currencies and securities. That keeps the yuan cheap, Chinese goods artificially inexpensive at Wal-Mart, and U.S. products very expensive in China.

Other Asian governments must follow variants of Chinas strategy lest their industries lose markets to Chinese exports. Not counting oil-rich Indonesia, Asia accounts for more than $435 billion of the $810 billion U.S. trade deficit.

New taxes, budget cuts and hybrid cars cannot plug that hole. Without patching it, there is no hope for sustaining American public support for free trade.

International economists have long known a dirty little secret about free trade. A large country like China can manipulate international prices to its advantage and harm its trading partners, much like an abusive monopolist, if those actions go unanswered by other large countries.

By rigging currency markets and other bully tactics, China is doing just that: increasing employment in high productivity activities that compete in trade, and stealing those jobs from the United States and other western economies.

Like the United States, Chinas labor force grows at about 1 percent a year but its GDP advances at better than 10 percent; meanwhile President Bush suggests Americans should be content growing at 3 percent or less.

World Trade Organization rules recognize the harm that currency manipulation, subsidies and other industrial policies can cause, and empower members to take compensating actions if harmed.

Seen in this light, proposals like those offered by Congressmen Duncan Hunter and Tim Ryan, which would permit U.S. industries injured by an undervalued yuan to petition for countervailing duties, are not protectionist. Rather, those are sensible responses to Chinese abuses of free trade. Those would either motivate China and others to quit cheating on the rules of global commerce, or undo some of the harm to the U.S. economy by partially rebalancing trade and recouping some lost GDP.

U.S. multinationals like GE, Caterpillar, and IBM profit from Chinese protectionism by relocating jobs to China, India and other Asian destinations. Meanwhile, along with President Bush, their leaders have labeled as protectionists Americans protesting Chinese mercantilism and advocating measured, meaningful responses. That taunt has become the scarlet letter of American economic debate.

Such hypocrisy debases public dialogue, and sadly makes those leaders demagogues.

If you punch me in the nose, popping you in the jaw is not criminal battery.

Answering Chinese mercantilism with trade measures is nothing more than self defense.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.