The major conflict of the 21st century is about economic advantage and the weapons are not nuclear bombs but bilateral trade agreements. The emotions surrounding US-China relations reflect the challenges of balancing economic and military interests. Let us analyze the growth of China to decrease the negative impact, if any, and to maximise from trading terms.
- China’s real gross domestic product (GDP) is at an average annual rate of 9.7%, from 5.3%, its real per capita GDP increased to 3rd from 27th.
- Chinese exports increased from $18 billion in 1980 to $969 billion in 2006, while imports over this period grew from $20 billion to $791 billion.
- World Development Report informs that China’s GDP as a percentage of worlds GDP is 16.3% in 2006.
- According to Corden (1984) foreign direct investment (FDI) in China rose from $109 million in 1979 to over $72 billion 2005, the third largest overall FDI destination after the U.S. and the UK.
- Increase in assets of the millionaires and the middle class
- According to the World Bank, from 1981 to 2001, economic reforms helped raise more than 400 million people out of extreme poverty.1
- Increase in foreign exchange reserves from $2.5 billion in 1980 to $1 trillion
The gradual and incremental approach has been due to
- large accumulation of capital, gain in productivity leading to high domestic savings (51.1% in 2006) and fund for new investment,
- surge in FDI due to trade reforms and incentives,
- increased productivity by more than 3% annually from 1985 to 1994
At the point of diminishing returns, China’s growth will slow to a rate of the U.S. or Japan but as it has a lesser per capita income to the U.S., it has plenty of room for further growth. U.S. will still be a leading world player.
In 2004, the world trade grew 21.2 per cent—the highest since 1979. Major contributors were the increased trade between China and the U.S. and the recovery of international trade in Association of South-East Asian Nations (ASEAN) and Asian newly industrialising economies (NIE).Therefore, it is interesting to analyze China- Economic power of a developing country and the U.S.-current major economic power.
American well being will depend on how American goods are exchanged for Chinese goods, or known as terms of trade. America will be affected by China’s future growth which will also increase the demands on the world’s natural resources and commodities.
Bilateral trade among the two increased once they signed the MFN (most favoured nation) agreement in 1980.Accoding to World Development Report, total trade (exports plus imports) rose from about $5 billion in 1980, to $20 billion in 1990, to an estimated $343 billion in 2006. China is now the 2nd largest U.S. trading partner. But trade deficit of U.S. rose from $30 billion in 1994 to an estimated $232 billion in 2006; some analysts contend that the large U.S. trade imbalance with China indicates that China maintains a number of unfair trade practices that seek to restrict imports of U.S. goods and services while boosting Chinese exports. These include currency manipulation, trade and investment barriers, industrial policies, piracy of intellectual property rights, dumping, and low labour and environmental standards.
1 Poverty level based on the number of people living on less than $1 dollar per day standard, World Bank, Fighting Poverty: Findings and Lessons from China’s Success.
Threats to the U.S
The growing economic clout of China has raised the hackles of The United States; therefore a detailed examination is mandatory, (Elwell & Labonte & Morrison, 2007).
- What if China becomes the largest economy pushing U.S. to 2nd position?
China’s economy (GDP=$ 57,145, Table 1)2 could soon overtake the U.S. (GDP=$ 35,963, Table 1) economy in size, but Chinese living standards will remain significantly below those of the U.S. (refer to per capita GDP in table 1). Size will then only afford greater bargaining power in trade negotiations, (U.S. Census Bureau, Foreign Trade Statistics).Therefore, larger in economic size to U.S. will have less impact on U.S.3
- Growth in U.S. Exports to China and its consequences
According to U.S. Department of Commerce and USITC Dataweb, China is close to becoming the third destination after Canada, Mexico for U.S. exports accounting to 5.3% of their total exports in 2006.4 The top five U.S. exports to China in 2006 (based on January-November data) were semiconductors and electronic components (up 79% over 2005 levels), aircraft and parts (up 40%), waste and scrap (up 64%), oilseeds and grain (up 7%), and resins and synthetic rubber and fibbers (up 13%).
This growth is incremental further. Other than U.S., China is the largest commercial aviation market, world’s second largest consumer market (compared to 7th in 2004), with total household spending of $3.7 trillion (2004 U.S. dollars), accounting for 11% of world consumption (compared to 3% in 2004, Credit Suisse Jan. 6, 2006). Also, the cars sold annually will rise from 4.4 million units to 20.7 million units. The export potential is huge for the U.S.
Further, China’s merchandise imports will increase by nearly 4-fold over the next 10 years (from $792 billion in 2006 to $3,752 billion in 2015). Assuming U.S. exports to China grow at the same rate, U.S. merchandise exports could increase from $55.6 billion in 2006 to nearly $208 billion in 2015. Therefore, it is only a net plus gain for the U.S.
- The Growth of U.S. Imports from China
The ranking of China as a source of U.S. imports has risen dramatically, from 8th largest in 1990, to 4th in 2000, to 2nd in 2004-2006. The top U.S. imports from China for the first 11 months of 2006 were computers and parts (up 15% over 2005 levels), miscellaneous manufactured articles (such as toys, games, etc., up by 7%), apparel (up by 14%), audio and video equipment (up by 24%), and communications equipment (up by 29%).
WalMart imported more from China than England or Russia, close to $12 billion of consumer goods. This means that American corporations and shareholders enrich themselves by sub-contracting out to China and that America’s middle-class consumer’s benefit by being able to buy at affordable prices as against domestic production being affected is negated.
But with an increase in China as a destination for advanced technology products (ATP), U.S. is alarmed as the U.S. went from a $0.1 billion trade surplus with China for ATP to a $47 billion trade deficit.
2Purchasing Power Parity is a factor used to minimize price differentials and exchange rate fluctuations, convert foreign economic data in currencies into U.S. dollars, according to Economist Intelligence Unit, (EIU.)
3China will not overtake the United States as the world’s largest economy until 2018, EIU.
4In terms of merchandise imports, China will exceed those of the United States by 2014, Global Insight.
This increase in imports of ATP products (Table 2) question the eroding of U.S. technology leadership.5 China adds relatively little value to products such as computers and mobile phones before export. For example, assembly takes place in China, but research and development takes place elsewhere. They reflect China’s emergence as the location for final assembly of a small number of very popular consumer electronic products and U.S. remains a world leader in technology.6
- Increase of U.S. Direct Investment in China
Based on the report by Jackson, FDI was nearly $2.1 trillion at the end 2005 (on a historic cost basis, U.S. Bureau of Economic Analysis). Cumulative U.S. FDI in China at the end of 2005 was $51.1 billion (according to Chinese data), accounting 8.2% of total cumulative FDI in China, making the U.S. the third largest investor in China after Hong Kong and Taiwan with a larger substantial gain .7
- Impact of the employees in the U.S.
Imports can destroy jobs in the parts of the U.S. economy that produce the same products. But, gross job losses occur on a scale well beyond foreign trade, suggesting job loss due to foreign trade may be relatively minor occurrence. Any imbalance in goods trade will offset a compensating imbalance in asset trade. Moreover, both types of exports have a positive effect on domestic employment. When foreigners increase their purchases of U.S. goods, domestic output and employment rise. This will counter the loss of jobs caused by the increase of imports. As long as the Federal Reserve can maintain aggregate spending at an appropriate level, total output and employment will not change. It is reasonable to believe that the impact on U.S. is either a very small net job loss or a net job gain but it does have some negative effect on employment in particular trade-sensitive sectors of the economy.
A U.S. company can destroy jobs by diverting production abroad, but a foreign company can create jobs by diverting production to the U.S. Therefore, we might expect there to be outsourcing into and out of the U.S. economy. Mataloni (2004, Vol 84, pp52-56) has shown that during 1977-2001, employment in the U.S. by foreign MNCs grew by 4.7 million, exceeding the 2.8 million increase in employment in the foreign affiliates of U.S. MNCs. These indicate that the U.S. is more likely to be the destination than the departure point for foreign outsourcing.8
- Decrease of American Wages
Trade puts downward pressure on the wages of domestic workers resulting in “Race to bottom” between domestic and foreign workers. Differences in level of wages between countries are often a reflection of differences in worker productivity. Wages in the U.S. economy are high because worker productivity is high. Therefore, a comparison of the true differences in production cost between high-wage and low-wage economies is differences in unit labour costs, the wage per hour divided by output per hour. Dullien (2005) and Hung Kwan (2002) inform that the Chinese economy has found unit labour costs there to be 75% to 80% of the U.S. level.
5According to U.S. Census Bureau , ATP products include biotechnology, life science, opto-electronics, information and communications, electronics, flexible manufacturing, advanced materials, aerospace, weapons, and nuclear technology.
6 Taiwan has outsourced most of its notebook manufacturing to China for example.
7 U.S. has to borrow from other countries, if not China as result of the exchange rate peg.
8 For more details, refer Levine, CRS Report RL30799: Unemployment through Layoffs: What are the Underlying Reasons,
Considering capital, raw materials, energy, and infrastructure is relatively costly in emerging economies, absolute cost advantage to U.S. is nil, manufacturing should continue here.
But, economists calculate the presence of comparative advantage in the production of a good if there is no large absolute cost advantage to production. Differences in comparative advantage will arise between countries because of differences in the relative abundance or scarcity of the factors of production. This shows a disparate effect on the wages of American workers different skill levels.
Economies of scale are also a factor that holds up industrial wages in the face of low-wage foreign competition. Increase in competition itself spurs companies to higher levels of efficiency, which lowers unit labour costs and helps preserve higher wages. The impact of trade on wages in the U.S. is modest as trade was a contributing factor, but a minor one.9
- “Unfair” Trade Practices of China
U.S. accuses China of trade barriers, industrial policies to support state owned enterprises, low labour standards. Tariffs may create a level playing field and help those individual industries, but its overall effect could be to turn a positive-sum activity into a negative-sum activity with both countries as net losers. Dumping is biased and is a thinly veiled export protectionism measure. Although labour and environmental standards may be low now, with higher income from trade the eventual elevation of wage and environmental standards in these countries is inevitable. Finally, IPR piracy is an issue where economic costs outweigh any benefits.10 This issue is relevant in China as well, calling for a solid IPR enforcement regime in place. Therefore, barring IPR piracy, trading with China providing they operate from market based economy will be worth the risk undertaken.
- Undervaluation of Chinese currency and its impact
The maintenance of Chinese peg by increasing foreign reserves rather than gold or silver is a new form of mercantilism. From 1994 to July 21, 2005, China kept its exchange rate fixed to the U.S. dollar at a rate of 8.3 Yuan to the dollar. To reduce undervaluation, the Chinese government modified its currency policy on July 21, 2005, as in managed float.
The rapid increase in China’s foreign exchange reserves is mainly purchase of U.S. treasuries. This lowered interest rates on the U.S. government’s debt and increased interest-sensitive spending throughout the U.S. economy. Then, there is a balance scored amongst the net gain / net loss incurred by trade for the U.S.
- In case of takeover of companies of U.S. being taken over by China
Let us cite an example. This issue has been raised as a state-owned Chinese oil company bid for California-based Unocal. Unocal’s oil output accounts for a tiny fraction of U.S., it will not matter: Unocal’s oil and gas meet Chinese demand that would otherwise have to be met in world markets. But, finally they withdrew the bid, (Wayne & Jackson & Morrison). Where takeover is concerned, it will revitalize U.S. by an infusion of capital and increase competitiveness, employment and productivity with limitations to protect U.S. interests.
9This conclusion is also confirmed by the absence of any sustained deterioration in labour’s share of national income, which has remained at about 70% throughout the post-World War II era.
10The International Intellectual Property Alliance (IIPA) (2005) estimated China’s piracy rates in: motion pictures (93%), records and music (85%), business software (88%), and entertainment software (92%), refer [http://www.iipa.com].
- Rise in commodity prices of the world.
According to British Petroleum (June 2006), since 1998, China’s consumption of natural gas has increased by 137% and coal by 66%. Prices in these markets are more regionally determined than oil, so the effect on U.S. prices will be limited. China’s share of world GDP is rapidly growing, but its share of world GDP growth is still relatively small, thereby, reducing its impact on U.S. economy. U.S. should continue to trade further for maximum gains but force China to quicken economic and trade reforms, to transform into a market-based economy, ensuring preservation of self interests.
Suggestions to minimise the impact of threats to the U.S. for better trade:
- Expand sanctions for trade and investment restrictions, limit access to capital — Reduce purchase of U.S. treasuries.
- Require U.S. firms in China to disclose information of contracts, agreements regarding technology transfer and capital, and impose a code of ethics on them — regulatory effect and minimise China’s unfair trade practices
- Closely monitor Chinese in America—minimise guest worker problems.
- Use rules of WTO to create trade barriers for imports of steel and ATP products — retain leadership in technology.
- Require pre-license and end-user checks for sensitive products of self defence — in the interests of the military to check the growing intelligence threat.
- Provide economic development zones
Opportunities to the U.S
- Strong demand for imports like ATP products, from the U.S., reducing inflation, increasing consumer welfare and competitiveness
- China has emerged as a major assembler for U.S. in electronics at low labour costs. 58% of Chinese exports are produced by foreign-owned firms, with mainly U.S. investors earning a larger share of the gain.
- Local market in China is the fastest growing for automobiles, aviation, personal computers, consumer goods, offering a major export potential, (Table 1).
- In 2004, the U.S. exported $350 billion in private services; China exported mainly travel and tourism services and imports the rest like business services, financial services, insurance services, telecommunication services, and engineering services, leading to substantial gains for the U.S.
- China’s massive energy needs and challenging pollution problems offer significant opportunities for U.S. companies.
- Chinese purchase of limited U.S. treasuries decreases interest rates and budget deficit.
- Export limited technological transfer as China has not invested in new technology, but here, the U.S is already at a comparative advantage.
Concluding, the terms of trade within China—U.S. must continue for optimal gains, by minimising threats. But, the Chinese must be forced to impose and police the laws of contract, property and intellectual property rights and the hugely undervalued Yuan must be revalued upwards, but gradually, and as a matter of policy to transform to a market based economy. This will assure improvement in the U.S economy.
List of References:
- Elwell, C K., Labonte, M., Morrison, M W., (2007), CRS Report for Congress: Is China a threat to the U S Economy.
- Max W. Corden, (1984), The Handbook of International Economics, vol.1: The Normative Theory of International Trade, North Holland, Amsterdam.
- World Development Report, (2005), United Nations Conference on Trade and Development.
- World Bank, Fighting Poverty: Findings and Lessons from China’s Success.
- Economist Intelligence Unit database And World Bank, (1996), World Development Report, p. 25.
- Mataloni J R., (March 2004), A Note on Patterns of Production and Employment by U.S Multinational Companies: Survey of Current Business, vol. 84, no. 3.
- Sebastian Dullien, (2005), Economics Working Papers Archive, China’s Changing Competitive Position: Lessons from a Unit Labour Cost Based FEER)
- Hung Kwan, (2002), Research Institute of Economy Trade, and Industry, The Myth of Chinese Competitiveness: Are Low-Wages China’s Strength or Weakness.
- U.S. Census Bureau, Foreign Trade Statistics, available at
- British Petroleum, (June 2006), Statistical Review of World Energy.
- Jackson J K., CRS Report RS21857, Foreign Direct Investment in the U.S.: An Economic Analysis.
- Nanto D.K, Jackson K.J, and Morrison M W, CRS Report RL33093, China and the CNOOC Bid for Unocal: Issues for Congress.