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Global Economics

Rough Road Ahead for U.S.-China Trade

The U.S. move to slap Chinese glossy paper with duties on subsidy grounds changes the trade playbook—and creates further opportunities for discord

Abrupt and unilateral trade sanctions by the U.S. directed at China are scarcely a new phenomenon. Since China joined the World Trade Organization in 2001, the U.S. has slapped dozens of anti-dumping measures on Chinese exports—such as color TVs, wooden furniture, and steel, not to mention brassieres and bath towels—and made three separate appeals to the WTO on matters regarding Chinese subsidies.

But the decision on Mar. 30 to impose countervailing duties on imports of glossy paper manufactured in China is a game-changer. It marks a significant departure from past practices and could well signal some nasty months ahead between Washington and Beijing. With the U.S. heading into a Presidential election cycle, and given a $232.5 billion trade deficit with China, hectoring the mainland on trade is a very tempting political proposition.

Just how China will react long term is unclear (though trade officials blasted the U.S. move on paper products) and the Chinese government's recent policy of token measures instead of fundamental reforms may have to be revised. So far this decade, Beijing has managed to calm things down with the Bush Administration using some headline-grabbing purchases of U.S. goods.

Reversing a Policy

Last year Beijing announced a multi-billion dollar deal to purchase Boeing (BA) aircraft and there are reports out now that China will make $12.5 billion worth of additional purchases of U.S. soybeans, cotton, machinery, and electronics. But with trade numbers having grown so gargantuan, China's biggest trading partners—or at least the U.S.—aren't likely to be bought off so easily this time around.

By adding countervailing duties to its trade protectionist toolbox, the U.S. is reversing a 23-year policy against such measures when it comes to so-called non-market economies such as China. One reason is that the U.S. Commerce Dept. has usually argued that identifying a specific subsidy underpinning an export sector is a very tough thing to do in a country such as China, where free land and cheap tax credits, not to mention preferential pricing between state-owned suppliers, are prevalent.

"This new development is very important," says Wang Yong, director of Beijing University's Center for International Political Economy. "The U.S. is changing the rules of the game between the two countries." The view that Washington is ratcheting up the pressure is shared by Shanghai-based Standard Chartered's Stephen Green who says this focus-shift to punishing Chinese companies for the alleged government breaks they receive is "a landmark development" for U.S.-Chinese trade relations.

All Exporters Vulnerable

He reckons this latest move could pave the way for the U.S. to impose duties on all sorts of Chinese companies, and on Chinese-based companies in which foreigners have a stake, an opinion shared by many in Washington. Frank Lavin, the U.S. Under-Secretary of Commerce for International Trade, suggested in a recent speech hosted by the National Association of Manufacturers in Washington that the action on Chinese coated paper makers has "implications [that] could go well beyond this case and its particulars."

But by ruling that value-added tax exemptions and bank loans of any kind are a form of subsidy, any mainland-based exporter is potentially vulnerable, including foreign firms. That means, for example, a foreign manufacturer, based in the heartland city of Chengdu, that received a favorable land deal and a cheap loan could be fair game if its exports to the U.S. were viewed as damaging.

While this new U.S. trade strategy will be targeting primarily Chinese firms, even a very aggressive campaign would make little difference in the lopsided bilateral trade numbers between the countries. The U.S., for instance, only imported $224 million worth of coated paper from China last year, a fraction of the $287.8 billion in total imports from China last year.

No Dampening Demand

Deutsche Bank China economist Jun Ma points out that part of China's supercharged export performance has less to do with state subsidies and more to do with much-improved products. "There has been a massive upgrading of products and technology in Chinese firms which has increased their competitiveness and allowed them to increase their market share," he says.

What's more, a 4% increase in the value of the yuan against the dollar in the past 18 months has done little to dampen foreign demand for Chinese-made clothing, flat-screen TVs, and electronic components— many made by firms in which foreigners have invested.

There is no way around the fact that manufacturing jobs will continue to shift to China, and not just in labor-intensive industries. On Mar. 26, Intel (INTC) announced it would spend $2.5 billion to build a wafer fab facility in the coastal city of Dalian, its first such investment in Asia. "That's the major trend in the whole debate and it's very painful for U.S. workers," says Standard Chartered's Green. "Much of the rhetoric from the U.S. is glossing over that whole issue."

China, of course, has to think about its workers too. With some 80 million jobs tied to China's booming export sector, Beijing is unlikely to heed pressure from U.S. Treasury Secretary Henry Paulson or anyone else to accelerate the pace of yuan appreciation. "Sure, the renminbi is undervalued, but it is a red herring in terms of where Washington should be spending its political capital," says Green.

He suggests that the U.S. put more effort into pressuring Beijing to improve protection of intellectual property rights, where the benefits of better enforcement would translate into huge gains for U.S. companies. Indeed, as Chinese companies start developing valuable brands, trademarks, and copyrighted works of their own, the chances of making progress against pirates and counterfeiters look a lot better than they do with piecemeal measures such as countervailing duties.

Anyway you cut it, though, things could get nasty on the trading front between the U.S. and China.

Click here to view a slide show of China's impact on the global economy.

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