Five Options for Tackling Trade With China

For one day—Monday, June 21—America's economic relations with China seemed to be on the right track. The Chinese currency jumped in value following a weekend announcement by the People's Bank of China that it would increase the flexibility of the exchange rate. A stronger yuan raised hopes for U.S. exporters trying to penetrate the booming Chinese market and gave domestic American producers competing with cheap Chinese imports a much-needed boost at home. Treasury Secretary Timothy Geithner said China's move would "make a positive contribution to strong and balanced global growth."

On June 22, the relationship was back to normal. The yuan gave up half of the previous session's gains as traders concluded that the central bank's commitment to flexibility did not imply a large and sudden increase in the yuan's value. U.S. labor leaders and some members of Congress argued that China's announcement was timed to deflect criticism by the U.S. and other nations at the Group of 20 summit in Toronto on June 26 and 27. "It looks to me like it was kind of a head fake. They're not contemplating anything like what we need," says Clyde Prestowitz, president of the Economic Strategy Institute, a Washington consulting firm.

The episode conveys an important lesson about the prolonged stress in U.S.-China economic relations: There's no easy solution that will suddenly make the superpowers synergistic. Americans blame China for not letting the yuan rise significantly, for not enforcing U.S. patents, for not putting American-made products on an equal footing with Chinese ones. China blames the U.S. for not putting its own fiscal house in order. Beijing fears that any rapid policy change would spur domestic unemployment and social instability. As China grows, U.S. influence shrinks. "What we're finding is that the United States is bumping up against the limits of the tools that it's had available," says Evan A. Feigenbaum, a Deputy Assistant Secretary of State in the George W. Bush Administration who heads the Asia practice at the Eurasia Group, a New York-based consultancy.

The U.S. can't just ignore China. It's the fastest-growing major economy in the world, at around 10 percent annually since the mid-'90s. The U.S.-China Business Council points out that exports of U.S. goods to China have risen 330 percent since 2000, vs. an increase of just 29 percent to the rest of the planet. And cheap imports from China have held down the U.S. cost of living.

What, then, can the U.S. do to get the most out of its economic links with China? Here are a few options:

1. Block China: In a March New York Times column, Paul Krugman, the Nobel laureate Princeton University economist, advocated for the U.S. to impose a temporary 25 percent tariff on imports from China until the country meaningfully raises the value of the yuan. Krugman elaborated on his argument in an interview with Bloomberg Businessweek, saying that by keeping its currency undervalued in a period of sluggish global demand, China is, in effect, exporting its unemployment problem to the U.S. "It's a world where mercantilism actually works and hurts the other guy," Krugman says. Even if China refuses to back down on the currency clash, Krugman argues, the U.S. would come out ahead because the tariffs would create more jobs at home without causing inflation.

The problem with unilaterally imposed tariffs is that China would undoubtedly protest them at the World Trade Organization—and might well win sanctions, forcing the U.S. into an embarrassing retreat—or worse, deliberate defiance of the global trading rules it helped invent, says Morgan Stanley Asia (MS) Chairman Stephen Roach. "You don't suspend the rules of free trade during recessions."

2. Declare an Emergency: Ian Fletcher, an adjunct fellow of the 77-year-old U.S. Business & Industry Council and author of the bluntly named Free Trade Doesn't Work, says President Barack Obama should make like President Richard Nixon circa 1971 and declare a balance-of-payments crisis, meaning that the U.S. can't cover the cost of its imports. That, he says, would entitle Washington to impose tariffs on imports from all countries. "People have to be willing to get some serious blood on the carpet," says Fletcher. Although less discriminatory than China-only tariffs, Fletcher's solution would undermine America's claim to leadership of the global trading system.

3. Use the WTO: China reformed its communist economy to qualify for the World Trade Organization, but has backslid since gaining membership in 2001. The "indigenous innovation" drive that accelerated last year—an attempt to become technologically self-sufficient by learning from the West—is the latest manifestation of a Chinese tendency that goes back to the Self-Strengthening Movement of the Qing Dynasty in the late 19th century. The U.S. could use the WTO more aggressively to stop China from favoring domestic products over imports, says Robert Cassidy, who was an assistant U.S. trade representative responsible for China under President Bill Clinton. China takes WTO compliance seriously. The problem: China has learned to play the WTO game. "China knows better today how to pursue its industrial policies with tools that won't trigger a WTO case," says Ted Dean, vice-chairman of the American Chamber of Commerce in China.

4. Talk, Talk, Talk: The more points of contact there are between the U.S. and China, the better the chances of progress. A program known as the U.S.-China Strategic & Economic Dialogue, begun under President George W. Bush, widened the conversation between the U.S. and China beyond trade issues to include currency and economic concerns. The periodic U.S.-China Investment Forum, also begun under Bush, brings Americans into contact with the central planners of China's National Development & Reform Commission. Chinese importers, consumers, and even techies often have interests that align with those of the U.S.

Opposition last year from Chinese Internet enthusiasts forced the government to back down from a plan to put intrusive filters on all personal computers sold in the country. "We need to be able to find ways to work with constituencies within China that agree with us to attack those that don't," says Charles Freeman, an assistant U.S. trade representative in the Bush Administration who is now with the Center for Strategic & International Studies think tank in Washington. One obvious potential snag, however, is that China is famously sensitive to any perceived foreign meddling.

5. Get America's House in Order: China isn't forcing Americans to live beyond their means. If the U.S. consumed less and produced more, its trade deficit with China—and the rest of the world—would shrink. Says Morgan Stanley's Roach: "We ran bilateral trade deficits with over 90 countries. The reason we did that is because we don't save."

Innovation is as essential as saving. To justify a standard of living that's far above China's, the U.S. ought to produce goods and services that China is incapable of producing, and for which the world is willing to pay a premium. "Even if China didn't exist, we might want to do more R&D here," says Douglas Irwin, an economics professor at Dartmouth College who advocates free trade.

Putting things right at home is more easily said than done. Even as China proclaims that boosting consumption is a national priority—thereby recognizing the need to rebalance its economy—it is fighting the market forces that would reduce savings rates in China and raise savings in the U.S. That's the whole point of buying $900 billion of U.S. Treasuries to keep the dollar up and the yuan down. As for technical excellence, U.S.-based multinationals aren't making it easy for American workers to excel: They are building some of their most advanced facilities in China and training Chinese workers to operate them, Prestowitz notes.

No approach to China is foolproof. "If we think we're going to find a silver bullet, we ain't got one," says Myron Brilliant, senior vice-president for international affairs at the U.S. Chamber of Commerce. The only option is to make the best of a difficult situation, remembering that both sides have a lot to lose.

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