To Trade or not to Trade, That is The Question

[2009-02-23 10:38:42]

Debate on the Chinese currency reflects the rising ambivalence about free trade and the new pressures of financial protectionism.

"President Obama - backed by the conclusions of a broad range of economists - believes that China is manipulating its currency," noted new U.S. Secretary of Treasury, Timothy F. Geithner in late January, hinting at a harder line on U.S.-China relations.

Only a week later, however, Vice President Joe Biden said that there had been no judgment in the administration over currency manipulation.

During the past eight years, the Bush administration avoided the term "currency manipulator," even when it had disagreements with China. The Obama administration's real litmus test will follow in April, when the administration is required by a 20-year-old trade law to report to Congress on exchange rate issues.

If the report deems China is engaging in "currency manipulation," such a finding would begin with a legal process that starts with diplomacy but could trigger the imposition of trade barriers and end in a trade war.

Unsurprisingly, Geithner's statement was in response to a question by Senator Charles E. Schumer, a vocal Democratic critic of China's currency policies.

The story goes back to the presidential primaries in the summer of 2007, when senators Barack Obama and Hillary Clinton agreed to co-sponsor controversial legislation that would have permitted US companies to seek anti-dumping duties on Chinese imports, based on the undervaluation of the currency.

Initially, the bill had been crafted by a bipartisan group of senators, including Senator Schumer. It called for a trade case to be brought by the U.S. at the World Trade Organization. It would also have applied 27.5 percent tariffs on Chinese goods and violated international trade rules.

At the time, Senator Obama criticized what he called "China's currency manipulation," urging U.S. Treasury Secretary Henry Paulson to take action against China.

Well, that was two years ago, when the world was a very different place. The global economy was not on the edge of a financial meltdown and the US banking system was not yet technically insolvent.

Recently, the IMF's chief, Dominique Strauss-Kahn, said the world's advanced economies - the U.S., Western Europe and Japan - were "already in depression," and that the IMF could further slash its global growth forecasts. "The worst cannot be ruled out," he added.

Now President Obama and Secretary of State Hillary Clinton are in a position to implement their campaign pledges, if they so decide.

However, those pledges made little sense in 2007. Today, they make no sense.

According to some members of the U.S. Congress, "currency manipulation" gives Chinese producers an unfair advantage against their American rivals by making Chinese imports artificially cheap and U.S. exports to China more expensive.

The assumption is that the depressed U.S. manufacturing output and the destruction of U.S. jobs is due to currency manipulation.

However, there is no commonly accepted definition of currency manipulation. Also, China is among the 50 percent of IMF members that fix their currencies, and its central bank has been gradually moving toward a more flexible arrangement.

The global financial crisis was triggered by the U.S. subprime mortgage crisis, and the ensuing credit squeeze - not by the renmibi.

Cheap imports from China have not been the primary cause for the decline of the manufacturing output or job losses in the U.S. economy.

Initially, Japan was the regional export platform in East Asia. Over time, it has been augmented by the tiger economies (South Korea, China's Taiwan, Hong Kong and Singapore). In the past decade or so, China has become the final assembly for East Asia's extensive and deepening manufacturing supply chain.

Due to the transformation of the regional export platform, Americans no longer purchase final products from Japan or tiger economies. Today, the notebooks, mobile handsets and flat-screen TVs sold in the US are increasingly assembled in China with components from throughout the region.

During the past decade, the share of the U.S. trade deficit accounted for by China and East Asia has actually declined significantly, from 75 per cent to 49 per cent.

Rising imports from China have not displaced domestic U.S. production but imports from the newly industrialized East Asia.

In the past, Chinese manufacturers specialized in lower-tech, labor-intensive goods, in contrast to the higher-tech, capital-intensive goods that were the comparative advantage of U.S. manufacturers.

Due to Beijing's innovation policies, these low-productivity industries are now migrating to less prosperous provinces in China.

The primary reason for the decline of US manufacturing and job losses is not China, but America's strong productivity. Today, domestic manufacturers can produce much more with fewer workers because remaining manufacturing workers are much more productive.

In the late 19th century, increasing productivity allowed America to move from agriculture to manufacturing; in the late 20th century, it boosted the transition to the knowledge economy. China is not fighting the trend, but seeking to follow in the footprints.

Despite the global financial crisis, the U.S. productivity machine continues to climb higher. Overshadowed by the drumbeat of negative economic news, U.S. productivity actually grew 2.8 per cent in 2008, the fastest since 2003. That is a stunning achievement amidst a near-global recession, even if it also reflects front-loaded job cuts.

In the 1990s, the U.S. technology revolution contributed to global growth. In the near future, global recovery requires new sources of productivity, not scapegoats.

New growth drivers do not have to result in a win-lose competition between the U.S. and China. In fact, the proposed green recovery - that is, the development of clean technologies through new energy and environment policies - could build on closer and mutually beneficial U.S.-Chinese cooperation.

Due to the critical role of the U.S. economy in global growth, the debate is no longer just about U.S.-Chinese economic relations.

It was only after strong criticism from major U.S. trading partners and the concern of President Obama that the Senate recently softened (but declined to remove) a protectionist "buy American" provision in the stimulus bill. The controversy reflects the U.S. administration's ambivalence over free trade.

The World Trade Organization has called for a meeting to discuss a fast-rising wave of barriers to commerce, as governments scramble to safeguard key industries, often at their neighbors' expense.

Instead of a repeat of a 1930s-style tariff war, however, the new form of protectionism stems from efforts to protect national financial markets.

Ahead of her trip to Asia, Secretary of State Hillary Clinton said she would deliver a message about America's desire for "more rigorous and persistent commitment and engagement".

Imposing punitive, unilateral sanctions against imports from China because of its foreign currency regime would be a massive policy blunder. True engagement is now needed more than ever before.

The author is the Research Director of International Business at the India, China and America Institute.