My Blog

September 15, 2007

This should be an unnecessary posting, but the topic has become so politicized that it has become hard to discuss without recriminations, and a lot of silly things are being said around it.  In the eagerness to assign “blame” for the US-China trade relationship, those in the it-ain’t-China’s-fault camp, and especially the Chinese press, love to point out that since a significant portion of Chinese exports to the US are from US multi-nationals, it must be US corporate policies, and not Chinese economic policies, that are to “blame” for the trade imbalance.  Bu this position makes no sense at all.

I don’t remember what portion of US exports are from US multinationals, but someone on Brad Setser’s blog (which, for those of my readers who don’t already read it, is something you should read regularly) claims that the number is 60-70% of total Chinese exports to the US.  This, he claims, proves that it is the fault of American corporations, and not Chinese policy-makers, that China is running a trade surplus with the US. 

Wrong – it proves nothing of the sort.

Imagine for a moment that the US suddenly passed a law making it illegal for any US corporation or subsidiary to own assets in China (and assume, unrealistically, that there were no other changes in the political relationships between the two countries).  Would the 60-70% of the Chinese trade surplus with the US immediately disappear?  Of course it wouldn’t.  The production and sale of those goods to the US would continue exactly as before, only now the facilities would be owned by Chinese (or Germans, or Japanese, or Brazilians or anyone else who took over the facilities).

Why?  Because the conditions that made it profitable to manufacture in China and sell to the US would not have changed.  Wages in China would still be low, infrastructure would still be solid, credit would still be excessive, and the RMB would still be seriously undervalued.  Meanwhile the US would still be a net recipient of capital, so that US consumption would still have to be higher than its production (i.e.it must run a trade deficit).  And Americans would still buy from China.  When Jones & Company manufactures a widget in China and sells it in the US, they do exactly the same thing that Zhang & Co. would do (ok, perhaps Jones & Co. knows a little more about marketing in the US and Zhang & Co. does a better job of getting a good deal in China, but you get my meaning).

China is running a trade surplus with the US in part because it has found itself locked into a currency regime that forces industrial production up without a commensurate increase in consumption.  The national origin of the exporter is irrelevant to the process and only reflects the importance of US corporations (especially in the US market) and the value both countries assign to the US-China relationship.  It does not affect the size of the trade relationship.

So does that mean I am in the blame-China camp?  No, because I do not think that the existing trading relationship is a serious problem for the US (although I do think it is a problem for China, as I have written many times before).  Since the US trade deficit is caused, in my opinion, not by the outrageous spending habits of Americans but because of the global excess savings – in most cases caused by specific savings-inducing policies in a number of countries – I do not believe that the question of what will happen when foreigners finally decide that they are “tired” of financing US excess consumption is an interesting question.  For me a better question is to wonder what will happen when China and Japan are “tired” of domestic policies that generate large savings (and so large trade surpluses), or what will happen when OPEC is “tired” of high oil prices.  Many things will happen, and they won’t necessarily result in the collapse of the US empire (which has anyway been collapsing unsuccessfully for nearly 90 years – since the early 1920s if I remember correctly, and most dramatically in the face of the Japanese onslaught of the 1980s).

Furthermore, and this may be a little more controversial because it requires some focus on long-term demographic trends, I think the US trade deficit is a necessary precondition for a world which will need to pay for a US trade surplus some time in the future.  The US economy and financial markets sometimes act, and have acted for many years, as a kind of residual that absorbs the various needs and requirements of the global economy in the aggregate – changes in the US force changes in the world, and vice versa.  In Europe, Japan and Russia today, and in China in about five years, we will begin to see a significant deterioration in the dependency ratios (as part of the aging process) that will require very heavy economic adjustments.  It is hard to overstate how dramatic and challenging these adjustments will be, and I frankly am a little pessimistic about the resulting prospect for all four countries.

But one thing is almost certain – these adjustments will have to be paid for by liquidating foreign claims, and the only market large enough in which to accumulate these claims is the US.  During this process the US will probably switch from being the world’s largest debtor to becoming a major net creditor in order for these countries to adjust.  By the way this isn’t unprecedented.  At the beginning of WWI the US was, as now, the world’s largest debtor nation.  By the end of the war it was the world’s largest creditor – because the European belligerents liquidated their claims against the US to pay for the war effort.  The adjustment required by aging countries will be far more costly economically than WWI, but fortunately spread out over a longer period of time.

Comments (8) for "Did US corporations "cause" ...

The trouble with "blaming" anyone is that anything that happens in political and economic systems is usually the result of lots of people making lots of unconnected decisions which interact in unexpected ways. One interesting point is that age structure has a huge impact on economics, and countries benefit from having lots of working age people to support old people (Ireland and China-today) and the get hurt by having an aging workforce and fewer working age people (Japan-today and China twenty years from now). It's interesting to see why the United States has escaped this problem. Immigration....... The United States is not only the sink for the world's capital, it's also the sink for the world's labor. Without continuous immigration the United States would be faced with a negative population growth and an aging population and would end up with the same sorts of problems as Japan. Also the fact that China's population is aging is why I think that the idea that China is "saving too much" is incorrect, and why I think that the trade deficit isn't just a bad thing. What the big problem is right now is that there is too much saving in China for the domestic capital markets to deal with, and that calls for loosening up restrictions on capital outflow overseas. One final thing. People have been predicting the downfall of the United States for decades, and people have consistently gotten this wrong. One very, very wise decision that the Chinese leadership has made was *not* to bet against the United States, or to make a rising China dependent on a falling United States. By Twofish - 9/15/2007 9:20 PM

One other point. They aren't really "American corporations" they are "multi-national corporations headquartered in the United States" (and in some cases they aren't even headquartered in the United States). The modern multi-national corporation has so many different activities occurring in so many different places, that it usually doesn't make any sense to think of themselves as belonging to one country, and the another wise decision that the Chinese leadership has made is not to fight the multinationals but to buy into them. The United States does well in this environment because it is itself a "multinational nation." I'm moderately worried about things like the Chinese savings glut, but what really has me worried is something else. At this point, the people who really want to challenge the global economic system are really on the margins. What worries me is something like the assassination of Archduke Ferdindad in Saerejvo in 1914. Some seemingly minor incident that spins rapidly out of control and which destroys the system. By Twofish - 9/15/2007 9:41 PM

Your usual insightful analysis, but your use of the value-laden term "imbalance" to describe the trade relationship shows why it's so hard to talk about trade using the prevailing vocabulary. "Balance" in trade terms just means "differential" or "leftover amount" (as in "bank balance") and it makes no more sense to talk about "imbalance" in trade than it does to talk about "imbalance" in your bank account. The normative content of the word "imbalance" is so strong that I think it's impossible to hear it without concluding that "balance" is more appropriate. And 99% of members of Congress seem to think this way; they certainly talk this way. But it's simply not true that the appropriate and desirable trade balance between any two countries is zero. A given bilateral trade differential might be good or bad, but never because it was not equal to zero. I'm sure you don't disagree with any of this; it just goes to show how hegemonic this unfortunate vocabulary is. By Don Clarke - 9/15/2007 11:37 PM

Twofish, I agree that the prospective aging of the Chinese population (and Europe and Japan too) makes the concept of excess savings tricky. Their savings are probably not excessive if we think in terms of the cost of their future adjustment and their need to acquire assets today to pay for that adjustment. At a global level, however, if their consumption level is too low to absorb the result of their investment and their employment needs, than their savings are too high. I think the huge demographic shift of the coming decades does require certain trade imbalances today (and you are right, Don, that imbalance -- which to me just means that it doesn't add to zero -- may have irrelevant normative content). I think we both agree that the problem is really that for China, the high savings rate has very important (nd dire) consequences for domestic monetary conditions. I am not sure it wll be easy to address this problem. By Michael Pettis - 9/16/2007 8:40 AM

The really fact is that the second biggest lender to the United States after Japan is China. U.S. prosperity and global influence depends heavily on Chinese financing. Of course, China’s prosperity depends significantly on exporting to the U.S. market and therefore on U.S. economic health. China ’s tremendous economic growth creates new opportunities and challenges for U.S. businesses. Between 1978 and 2002, China's annual GDP growth reached 9.4%, three times the world's average, and in recent years (2001-2004) China accounted for one third of global economic growth. Boosting U.S. exports to China is the right step to narrow the trade gap. China exports millions of pairs of jeans, or millions of boxes toys in exchange for an airplane. If the U.S. government allows more high-tech products to be exported to China, the trade imbalance could easily be improved. Welcome to AmeriChinaB2B( http://www.acb2b.com/ ) to begin your business trip of China. By Lucia - 9/16/2007 11:55 PM

I don't think the term "imbalance" necessarily implies that the bilateral trade differential between two countries must be zero. Furthermore, I don’t think many in Congress believe that US-China trade must be “balanced.” That is to say, that the net trade between the two countries must be equal. Rather, when referring to the US-China trade deficit, "imbalance" seems to refer to China's interventionist currency policy that results in substantial price distortions skewing bilateral trade. Without that distortion, I think that many (but certainly not all) would be amenable to not using the term, however, I don’t know if they would say that trade is “balanced.” Of course, one can certainly debate whether this vocabulary is ultimately “representative”of reality or even “hegemonic.” However, that would seem to be a question for Wittgenstein and Foucault, not economists. By Erik - 9/17/2007 8:58 AM

To Erik: I must respectfully disagree. I think that almost always whenever people say trade is "unbalanced", they are referring to the exact amount of the current trade deficit (or surplus). They don't say that the imbalance is the difference between the current differential and what the differential should be without intervention in the currency value. For example, I remember an Asian WSJ op-ed piece of Aug. 1, 2003, in which Hugo Restall - I don't want to pick on him in particular - referred to the US-China trade balance as being $103 billion (just the amount of the deficit) "out of kilter" "in favor of" Chinese exporters. This is symptomatic of the prevailing mindset in two ways: (1) any differential means that something is out of kilter; and (2) a bilateral trade surplus is something that is in your "favor", and a bilateral trade deficit is something that disadvantages you. There's no way to prove conclusively whether you or I are right in our impressions of what the prevailing discourse says. Let's just leave it to readers of these comments to decide whether in their experience my impression of how people use the term "imbalance" is accurate or not. As I said in my first comment, the concept of "imbalance" does not even properly apply to "balance" in the term "trade balance" any more than it applies to "balance" in your bank balance. You would not say that having a positive (or negative) bank balance was a symptom of "imbalance" in your personal finances. These are two quite different meanings of "balance" that have unfortunately been conflated. By Don Clarke - 9/17/2007 10:17 AM

Part of the art of politics is using terms that will get the most support for your side while demonizing the opposition. I don't mind the term "imbalance" because China causing an "imbalance" is one step better than the previous discourse which had China as a "manipulator." The big problem with all of this use of language is that sometimes obscures what people really want. In the case of Chinese trade, there are two constituencies for RMB appreciation in the United States. Textile manufacturers who are interested in protecting jobs, and Wall Street that wants to see ultimately the end of capital controls. Curiously there doesn't seem to be that much interest in RMB valuations in importers other than textiles, and this is largely because textiles are special. For auto parts for example, a change in RMB appreciation would just move the factories to Mexico. In both cases, these constituencies got what the wanted, and are now pretty quiet. Textile manufacturers got China to agree to export limits on textile manufactures, and Wall Street is getting China to relax capital controls on exporting capital. One important part of these two groups is that neither is out for blood as are the neo-conservatives were. Given that the groups have gotten what they wanted, there is now remarkably little pressure to "get tough" on trade, and the pressure is likely to get even less in the coming years. One fact about this debates is that once an industry moves all their the factories move to China, there isn't a constituency in the United States that complains any more, and so over time, it's likely that the subject of persistent US deficits is going to get less and less attention. That's on the US side. On the Chinese side, the problem is that I think pumping the Chinese economy with paper is going to cause something to break eventually. The rule is that something that can't go on forever won't and I think we are beginning to see signs that China is simply reaching the limits of the amount of dollars it can absorb. One other point. The reason that a lot of the attention has been focused on China is that talking about revaluing the RMB makes a difference. The Chinese leadership like politicians everywhere are worried about losing power, only in the Chinese case, the means of losing power are unlikely to be quite as genteel as they are in the United States. However, this does mean that these sorts of debates, make a difference, and the Chinese leadership has obviously been listening to the conflicting advice that economist have been giving it, and trying to formulate some policy. By contrast, if you go to the US and talk about cutting deficits, no one will listen to you. One thing that worries me is that even if China does manage to muddle through (and if it doesn't, we are all in big trouble), that this leaves the US with some serious fiscal issues that are simply not part of public discourse. By Twofish - 9/17/2007 11:49 AM