Smith Faculty Opinion Article March 9, 2006

Trade Deficit Hits Another Record
Congress Should Compel Concrete Action toward China

By Dr. Peter Morici, Professor of International Business

Peter MoriciToday, the Commerce Department announced the January trade deficit was $68.5 billion, up from $65.1 billion in December.

The consensus forecast for January was $66.6 billion. My forecast published by Reuters was $68 billion.

The trade deficit exceeds 6 percent of GDP and is weighing down economic growth.

Although petroleum plays a key role, it is certainly not the whole story. Since December 2001, the monthly trade deficit has increased by $42 billion. Petroleum accounts for less than half of that change.

The Wal-Mart effect is broadly apparent. The January trade deficit with China was $17.9 billion, up from $16.3 billion in December

This situation is likely to become worse in the months ahead. The dollar remains at least 40 percent overvalued against the Chinese yuan, and similarly overvalued against other Asia currencies too.

China continues to peg against the dollar. Although China revalued the yuan from 8.28 to 8.11 in July, and announced it would adjust the currency to a basket of currencies, the yuan continues to track the dollar very closely. Currently it is trading at about 8.05.

China appears to be permitting the yuan to rise at a pace of about 3 percent year. Since implicit value of the yuan rises about 5 percent each year, the yuan will remain at least 40 percent overvalued for the foreseeable future. The overvalued dollar will contribute mightily to the U.S. trade deficit until the Bush Administration takes decisive action.

High and rising trade deficits tax economic growth. Specifically, each dollar spent on imports that is not matched by a dollar of exports reduces domestic demand and employment, and shifts workers into activities where productivity is lower.

Cutting the trade deficit in half would boost employment and productivity enough to raise GDP by $300 billion or about $2000 for every working American. Workers wages would not be lagging inflation, and ordinary working Americans would more easily find jobs paying good wages and offering decent benefits.

Longer-term, persistent U.S. trade deficits are a substantial drag on growth. U.S. import-competing and export industries spend three-times the national average on industrial R&D, and encourage more investments in skills and education than other sectors of the economy. By shifting employment away from trade-competing industries, the trade deficit reduces U.S. investments in new methods and products, and skilled labor. Cutting the trade deficit in half would boost U.S. GDP growth by 25 percent a year.

To maintain an undervalued yuan, China purchases about $200 billion dollars in U.S. and foreign securities, which it hoards. This creates a 33 percent subsidy on Chinese exports.

Manufacturers are particularly hard hit by this subsidized competition. Through recession and recovery, the manufacturing sector has lost 3 million jobs. Following the pattern of past economic recoveries, the manufacturing sector should have regained about 2 million of these jobs, especially given the very strong productivity growth accomplished in durable goods and throughout manufacturing.

The Bush administration has refused to take action against China.

The Congress is considering several bills which would compel action. Among these is a bipartisan bill by Congressmen Duncan Hunter (R-CA) and Tim Ryan (D-OH). It would add the subsidies provided by currency manipulation to the list of unfair trade practices actionable under U.S. trade law, and permit domestic manufacturers to petition the Department of Commerce and U.S. International Trade Commission for duties on Chinese imports to offset these subsidies.

The time is long past due for legislation like the Hunter-Ryan bill.

Peter Morici is a Professor of Business at the Robert H. Smith School of Business, University of Maryland and former Chief Economist at the U.S. International Trade Commission.

E-mail: pmorici@rhsmith.umd.edu