This week (January 18-21) U.S. President Obama and Chinese President Hu will engage in the "Give Away Summit." On the agenda at this week's negotiations in Washington, Obama will ask Hu to comply with WTO rules and also reduce his manipulation of the dollar-yuan exchange rate.
In return, Obama may offer to give Hu access to American products with military uses and he may offer to share NASA-developed space technology with China. These offers will please China's military, which holds ultimate power in China and which has been preparing for a confrontation with the United States, perhaps over Taiwan, Korea, or disputed Japanese islands.
But any Chinese concessions will clearly have little effect on the U.S./China trade balance. In 2010, despite the fact that demand in China was growing at about a 10% rate while demand in the United States was growing at about a 2.5% rate, U.S. demand for Chinese exports was growing faster than Chinese demand for American exports, as shown in the following graph:
This is not an accident. China keeps out American products through currency-manipulations, tariff barriers, and non-tariff barriers. Some of those barriers are permitted by WTO rules including:
- China's currency manipulations, which add about 35% to the cost of American products sold in China and subtract about 35% from the cost of Chinese products sold in the United States.
- China's tariffs on American products, including 25-30% tariffs on vehicles, mining machinery, textiles and raisins.
- China's government catalogs, which exclude American products from those that can be purchased by China's huge government-controlled sector.
- China's financing of state-controlled enterprises so it won't have to import American products, including China's competitor to Boeing (BA) and Airbus.
However, other Chinese barriers to American products do clearly violate WTO rules. In December, the United States Trade Office published its 2010 Report to Congress on China's WTO Compliance, which discussed China's progress in these areas in 2010:
In 2010, the prevalence of interventionist policies and practices, coupled with the large role of state-owned enterprises in China’s economy, continued to generate concerns among U.S. stakeholders about the direction of China’s reform. Major issues included China’s indigenous innovation policies, serious problems with intellectual property rights enforcement, and China’s slow movement toward accession to the WTO Government Procurement Agreement, as well as continued market access barriers and discrimination against foreign enterprises in many sectors of China’s economy. In a significant achievement this year, however, the United States was able to work with China through the JCCT and other bilateral engagement to address several of these concerns. (p. 2-3; pdf p. 10-11)
Here are some specifics on 2010 developments:
- Continuing piracy of intellectual property. "In addition, effective enforcement of China’s IPR laws and regulations remains a significant challenge. Despite repeated anti-piracy campaigns in China and an increasing number of civil IPR cases in Chinese courts, counterfeiting and piracy remain at unacceptably high levels and continue to cause serious harm to U.S. businesses across many sectors of the economy. The U.S. copyright industries estimate that losses in 2009 due to piracy were approximately $3.5 billion for the music recording and software industries alone. These figures indicate little or no overall improvement over the previous year. USTR’s annual Special 301 report, issued in April 2010, similarly confirmed a lack of progress through 2009, as USTR continued to place China on the Priority Watch List." (p. 5; pdf p. 13)
- Increasing requirement that U.S. R&D be moved to China. "In 2010, policies aimed at promoting 'indigenous innovation' became an important component of China’s efforts. For example, China began to link government procurement and other preferences to discriminatory criteria, such as the possession of intellectual property owned or developed in China. China’s industrial equipment catalogue also offered financial support to producers who exported or whose domestic products could substitute for imported products. In addition, in the wind energy sector, China pursued a range of preferential policies. In approving new wind power projects, China applied criteria that de facto discriminate against foreign enterprises, and provided subsidies to Chinese wind turbine system manufacturers that appear tied to the purchase of domestic over imported wind power components and parts. China also introduced restrictions on foreign investment in offshore wind power projects." (p. 6; pdf p. 14)
- Increasing Restrictions upon rare earth exports. "As in prior years, China continued to deploy export quotas, export license restrictions, minimum export prices, export duties and other export restraints on a number of raw material inputs where it holds the advantage of being one of the world’s leading producers. Through these export restraints, it appears that China is able to provide substantial artificial advantages, both in China’s market and other markets around the world, to a wide range of downstream producers in China. The U.S. response, as noted above, was the filing of a WTO case in June 2009 challenging the export restraints that China maintains on nine raw material inputs of key interest to U.S. industry. In 2010, China’s export restraints on rare earths – an important group of raw material inputs that had not been included in the initial U.S. WTO case on export restraints – began to generate increased concern among China’s trading partners, as China sharply reduced its export quotas and took other actions that created uncertainty about the stability of China’s supply. The United States pressed China to eliminate its export restraints on rare earths, including through high-level engagement at the December 2010 JCCT meeting, but to date China has not been willing to change its policies. Going forward, the United States will continue to pursue vigorous engagement with China on this issue and will not hesitate to take further actions, including WTO dispute settlement, if appropriate." (p. 6; pdf p. 14)
- Regulatory Restrictions on U.S. agricultural products. "In 2010, the principal targets of worrisome practices by China’s regulatory authorities were poultry, pork and beef products, where anticipated growth in U.S. exports of these products was again not realized. In particular, China continued to block the importation of U.S. beef and beef products, well over three years after these products had been declared safe to trade under international scientific guidelines. China also continued to maintain several unwarranted state-level Avian Influenza import bans on poultry, even after announcing the lifting of two state-level bans at the December 2010 JCCT meeting. Additionally, while China lifted bans on imports of U.S. pork and pork products in April 2009, it continued to impose a ban on imports of live swine, ostensibly related to its concern about the transmission of the H1N1 influenza A virus. China also continued to maintain overly restrictive pathogen and residue standards for raw meat and poultry." (p. 8; pdf p. 16)
Even though China made little progress in 2010, the report is optimistic about 2011 because of Chinese promises in recent negotiations:
At the December 2010 JCCT meeting, in a positive development, China committed to address several of the worrisome policies and practices that had taken on prominence in 2010. Specifically, China agreed not to provide government procurement preferences based on the nationality of intellectual property, committed to revise its industrial equipment catalogue and not to use it for import substitution or the provision of export subsidies or otherwise to discriminate against foreign suppliers, and to revise its criteria for approval of new wind power projects to recognize prior experience both inside and outside of China. China also committed to technology neutrality for 3G networks and for future networks based on new technologies and to ensure transparency, cooperation and non-discriminatory treatment of U.S. suppliers in the development of China’s smart grid market. (p. 7; pdf p. 15)
Even if China does follow through on its promises to improve its WTO-compliance during 2011, that won't much change our balance of trade with China, given that China will continue to manipulate the dollar-yuan exchange rate to keep American products relatively more expensive and Chinese products relatively less expensive. It will also continue to keep out American products through WTO-legal tariffs.
China's positive trade balance in 2011 will keep the Chinese economy humming at about a 10% pace, while America's negative trade balance in 2011 will keep the United States economy stagnant at about a 2.5% pace. As economist John Maynard Keynes explained in his 1936 magnum opus, The General Theory of Employment Interest and Money:
(A) favorable [trade] balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression. (p. 338)
If President Obama had decent economic advisors, he would be telling President Hu right now that future trade between the countries must be balanced, and that unless China moves to balance trade on its own, he will impose a WTO-compliant scaled tariff upon Chinese goods. As my father, son and I pointed out in a recent commentary:
Scaled tariff endorsed by WTO agreement
The United States and all other nations experiencing large, chronic trade deficits are entitled under World Trade Organization (WTO) rules governing international trade to impose barriers to imports from their offending trading partners. This rule was partly designed to insure steady growth in world trade. Balanced trade can grow forever, but imbalanced trade eventually bankrupts the trade deficit countries, ruining the markets for the trade surplus countries.
Article XII of GATT 1994, annexed to the Agreement Establishing the World Trade Organization, permits any country that has both a perilous external financial position and a balance of payments deficit in the current account to restrict the quantity or value of merchandise permitted to be imported in order to bring payments toward balance. With the United States net foreign debt in 2009 at 25% of GDP and the balance of payments deficit in the current account at 2.7% of GDP, the United States qualifies and is permitted to use import restrictions to balance trade. Such restrictions can include price-based measures such as import duties in excess of the duties inscribed in the WTO schedule for that member.
Countries that impose import duties under Article XII of GATT 1994 must progressively relax such import duties as the trade deficit grows smaller, maintaining duties only to the extent that a continuing balance of payments deficit in the current account justifies such application. Therefore, an import duty that is implemented under the authority of Article XII of GATT 1994 should go down in rate as trade approaches balance and should disappear when the balance of payments in the current account reaches balance or goes into surplus.
The scaled tariff complies with Article XII of GATT 1994 because it is suspended if the United States balance of payments in the current account goes to surplus and because its rate goes down when the United States trade deficit with a country improves.
At the "Give Away Summit," Obama may give Hu American technology in order to obtain slightly more balanced trade. But it doesn't have to be that way. He could obtain complete balance without giving away our military advantages, simply by invoking the relevant WTO rule.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I own Chinese yuan though CYB and I also own shares in Vanguard Emerging Markets Stock Index Fund (VEMAX)
