commentary

(Pittsburgh Post-Gazette)

October 30, 2005

Puts & Calls: Concerns Over U.S.-China Trade Deficit Are Overblown

by Julia F. Lowell

To hear some critics of U.S. trade with China tell it, China and its army of low-wage workers laboring long hours are like a giant vacuum cleaner sucking up American jobs, American factories, American dollars and ultimately American prosperity and transplanting them across the Pacific. But claims that U.S.-China trade is benefiting China at American expense don't hold up on close examination.

Trade opponents can point to some evidence backing their arguments. For example the U.S. Commerce Department released figures Oct. 13 showing that the August U.S. merchandise trade deficit with China reached a record $18.5 billion — almost a third of the total U.S. merchandise trade deficit. The figure continues a trend that began in the mid-1980s.

But merchandise trade balances don't take into account cross-border trade in services, where U.S. surpluses with China are steadily increasing. As China continues to develop, it will spend more money in areas such as tourism, insurance and business and financial services — all areas where American companies are highly competitive. Improved Chinese protection of intellectual property rights also will boost the U.S. services surplus by making it easier for American companies to collect royalties and license fees in China. Services trade surpluses, therefore, already help offset merchandise trade deficits with China and we can expect them to grow in the future.

In addition, recent research has shown that official U.S. estimates of America's trade deficit with China are overstated. Distortions in the measurement of costs associated with shipping, and the treatment of China's trade through Hong Kong, systematically understate the value of U.S. exports to China and overstate the value of U.S. imports from China. Taking these two factors into account, some economists now calculate that the true U.S.-China merchandise trade deficit is slightly less than 75 percent of the official U.S. estimates.

Some concerns about U.S.-China trade are legitimate, and the U.S. government uses a variety of measures to deal with them. These include safeguards against disruptive import surges, restrictions on exports of militarily sensitive items and enforcement actions against illegal trade practices. For example, working through the World Trade Organization, the United States recently prevailed on China to end its preferential tax treatment of domestically designed and produced semiconductors.

The structure of Chinese export industries provides another reason for not worrying about U.S.-China deficits. More than 55 percent of Chinese exports consist of "processed" goods assembled from imported parts and components. The financial capital, equipment and technological know-how needed to produce these exports are mostly supplied by companies headquartered in the United States, Japan, South Korea, Europe, Hong Kong and Taiwan. Many of these companies moved their manufacturing operations to China from locations elsewhere in Asia in order to take advantage of low-cost Chinese labor.

This export structure has implications for who gains from U.S.-China trade. Because a high percentage of the value of Chinese exports derives from imported parts and components, much of the benefit from sale of these exports does not accrue to Chinese investors or workers. Even in cases where import content is low, high levels of foreign ownership and investment in Chinese export industries mean that many of the profits are repatriated abroad.

All this suggests that the value added in China to Chinese exports is quite small. In fact, according to one study, $1 worth of aggregate Chinese exports to the United States back in 1995 induced a direct domestic value-added worth of just 19 cents. To equate Chinese merchandise surpluses (the counterpart to U.S. merchandise deficits) with Chinese power and profit is to misunderstand the nature of China's export industry.

In fact, the usual arguments about the economic gains from trade apply in spades to the United States and China. Trade between the two countries represents a classic example of comparative advantage, with China specializing in low-value, labor-intensive manufactured goods and the United States specializing in high-value goods and services. Chinese products, therefore, do not generally compete with American products either in U.S. markets or abroad. This means that U.S. job losses in manufacturing cannot be blamed on China.

The idea of a Chinese menace growing ever more powerful is an old one, harking back to the 19th-century fears of an evil "Yellow Peril" threatening Western civilization. And emotions run high when American workers see their jobs disappearing and their employers opening factories in China.

But in deciding what trade policies make sense for America, the nation's leaders need to objectively research and analyze the situation so they can determine the wisest course, looking at the long-term consequences of actions that may bring them short-term praise. In trade between the United States and China, there need not be a winner and a loser. Both nations and their citizens can be winners.


Julia F. Lowell is an international economist at the Rand Corp., a nonprofit research organization.

This commentary originally appeared in Pittsburgh Post-Gazette on October 30, 2005. Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.