Smith Faculty Opinion Article

Peter Morici By Dr. Peter Morici, Professor of International Business
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June 25, 2009

Fixing China Trade Key to a Sustainable Recovery

This week, the Obama Administration filed a WTO complaint against Chinese export practices that disadvantage U.S. manufacturers. This is welcome news, because more balanced trade with China is essential for achieving a sustainable economic recovery.

In 2001, the recent U.S. economic expansion began, and China was granted WTO membership and assured access into the U.S. market. By 2008, Chinese exports to the United States more than tripled to $338 billion, exceeding U.S. exports to China almost five to one.

Meanwhile, rapid growth in China and throughout Asia helped push up prices for oil, and the U.S. oil import deficit quadrupled.

The U.S. trade deficit increased from $93 billion in 2001 to about $700 billion a year from 2005 to 2008. That’s more than five percent of GDP, and China and oil now account for nearly the entire total.

Dollars spent abroad cannot be spent on U.S. goods and services. When imports exceed exports by 5 percent of GDP, Americans must spend 105 percent of what they earn, or the demand for U.S. goods and services is less than the supply, inventories of new homes, cars and other goods mount, layoffs result, and the economy slips into recession.

During the economic expansion, China and other foreign investors’ purchases of U.S. securities kept interest rates low on long-term bonds, even when the Federal Reserve raised its target rates on short-term paper. This permitted banks to offer mortgages and consumer loans on very attractive terms. Many Americans spent more than they earned, and this kept the economic expansion going. When the credit bubble burst, consumer demand collapsed and the recession followed.

The $789 billion stimulus will lift demand for U.S. goods and services temporarily. However, once that spending is done, either consumers again borrow and spend more than they earn to sustain demand for U.S. goods and services and keep the recovery going, or the trade deficit must be reduced significantly. Otherwise demand will flag and the recovery will collapse.

Reducing oil imports and better balancing trade with China are critical to a sustainable recovery.

Regarding oil, President Obama’s big push to get auto manufacturers more focused on fuel efficient, hybrid and electric vehicles is a partial answer. Producing more oil from abundant domestic reserves is needed too.

Trade with China with is lopsided because it pursues a mercantilist economic development strategy that blatantly violates commitments made to the United States and other WTO members when it was granted admission. China subsidizes exports through tax rebates, regulated raw material prices, and other industrial policies that expand its foreign sales far beyond manufactured products that benefit from its abundant low-wage labor.

China also keeps out products its manufacturers lack skills to make effectively. For example, U.S. and Japanese automakers are required to enter into joint ventures with Chinese companies, and produce vehicles and move parts suppliers to China to sell cars there.

Beijing maintains an undervalued currency by purchasing dollars with yuan on a regular basis and investing those dollars in U.S. Treasury securities. This provides the equivalent of a 25 percent subsidy on exports and disadvantages imports too.

Most recently, China imposed minimum prices, quotas, taxes, and other restrictions on critical materials used to produce steel, aluminum and chemicals. Often China is the key global supplier of raw materials, and its export controls disadvantage steel, aluminum and chemical manufacturers, and the industries that fabricate products from those materials, in the United States and elsewhere outside of China.

Such practices directly violate WTO rules, which require all members to export raw materials freely so that manufacturing takes place where it is most cost competitive, consistent with the basic tenets of trade based on comparative advantages.

The United States and European Union have initiated a formal complaint against these Chinese export restraints. U.S. Trade Representative Ron Kirk has correctly characterized these egregious practices as a thumb on the scale, disadvantaging U.S. manufacturers during a tough recession.

In announcing the WTO complaint, the Obama Administration noted the importance of manufacturing for creating high paying jobs, and hopefully, this will be just the first initiative to recalibrate trade with China.

Next the Obama Administration should tackle China’s undervalued yuan—its sweeping effect on U.S. industries competing with Chinese products make it essential to rebalancing trade with China and getting the U.S. economy back on a sustainable growth path.  

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