The US and China can beat the trade deficit with a treaty, not all-out war
Lawrence J. Lau says the first US-China economic dialogue ending without an agreement was not wholly unexpected, and calls for a bilateral investment treaty as a winning way to the future for both countries
The first China-US Comprehensive Economic Dialogue concluded in Washington on July 19 without an agreement. There was no joint communiqué. Even the scheduled separate press conferences were cancelled, first by the US, and then by China. What does this mean for their economic relations in the future?
First of all, such an outcome is not totally unexpected. For domestic political reasons, neither China nor the US can appear to make significant concessions at this time. On the Chinese side, the critical 19th congress of the Chinese Communist Party will be held within the next three months, and it is important for China to project confidence and strength. On the US side, President Donald Trump has not had much luck in fulfilling his campaign promises, such as repealing president Barack Obama’s Affordable Care Act, the building of a wall along the entire Mexican border, and renegotiating the North American Free Trade Agreement. The North Korean problem continues to look intractable. And there is the ongoing investigation of the Russian connection. Other proposals, such as the tax cut and the rebuilding of infrastructure, have not advanced. Trump needed a visible win, not a compromise, on this one.
Further, it is useful to note that neither China nor the US are accustomed to treating another country as a friendly equal. This makes negotiations between the two more difficult, because the usual proven approaches that work with the other countries do not necessarily work in this case.
Some of the American demands at the dialogue were actually not supported by even US businesses. For example, the lowering of automobile tariffs in China is not welcomed by General Motors or Ford, which have large manufacturing operations in China and benefit from the existing tariffs. The US threatened to impose quotas or tariffs on the imports of Chinese steel and aluminium. But these Chinese goods account for only a very small percentages of the total US imports of steel and aluminium, and will do very little to narrow the trade deficit. So any such action is merely symbolic.
There is also some possibility that the US may label China a currency manipulator, so that it can undertake additional protectionist measures against it. However, for the past year, if there was any manipulation on the part of China at all, it was to prevent the renminbi from falling against the US dollar, exactly the opposite of what it should do to gain an advantage for its exports. Moreover, one can also argue that through its quantitative easing policies, the US was actually an indirect currency manipulator.
The bilateral trade deficit is actually not as large as it appears. A recent study that looks at the domestic value added, that is, the GDP created by exports of goods and services to each other in the respective countries, gives an estimated US deficit of US$132.7 billion for 2015, compared to an estimate of US$367.4 billion based on US data on exports of goods alone.
Moreover, this value-added estimate does not include the value of patent licensing fees paid by Chinese enterprises to foreign (for instance, Irish) subsidiaries of US companies, such as Apple and Qualcomm, which can amount to many tens of billions of dollars, and which should properly be attributed as the revenue from US exports of services to China. If included, this would make the bilateral trade deficit even smaller.
The meeting next week with China will be a very difficult one in that we can no longer have massive trade deficits...
— Donald J. Trump (@realDonaldTrump) March 30, 2017
Further, it should be recognised that reducing the bilateral trade deficit is not the same as reducing the overall US trade deficit with the rest of the world. It is the latter that matters, in terms of helping American workers through increasing employment and wage rates. If, as imports from China fall, they are simply replaced by imports from other countries, US workers will not benefit in any way.
In reality, reducing the bilateral trade deficit by reducing bilateral trade (that is, both Chinese exports to the US and US exports to China) is not in the interests of American workers and consumers. The efforts of the economic dialogue should therefore be focused on increasing US exports of both goods and services to China, which can narrow the trade deficit and benefit both countries. For example, based on its existing domestic demand, China can import from the US large quantities of oil and gas, now that American restrictions on such exports have been relaxed. It can increase imports of high-technology products, if the export restrictions can be relaxed. It can increase imports of agricultural products such as beef, pork and rice, in addition to the already huge existing imports of corn and soy bean.
The number of Chinese tourists visiting the US will continue to rise, especially now that Chinese citizens are given 10-year multiple-entry visas. The number of Chinese students in the US will also rise rapidly.
Chinese restrictions on wholly foreign-owned commercial banks and life insurance companies are likely to be relaxed, as long as they are reciprocal, and the financial institutions satisfy threshold capital requirements and operate with domestically capitalised subsidiaries. With a coordinated effort, the US-China trade deficit can be significantly narrowed, if not closed altogether, within a few years.
A relevant factor for the investment relations between the two countries is the phenomenon of excess savings in China. Chinese national savings exceed 40 per cent of GDP each year and, given the existing excess capacities in almost all major manufacturing industries, cannot be productively deployed domestically. Thus, these excess savings will need to be invested overseas. The US will be one of the natural destinations.
There is therefore the necessity and urgency for a China-US bilateral investment treaty. The Chinese savings can also be invested in American infrastructure projects, either directly, or in their bonds, helping to realise one of President Trump’s campaign promises.
While some people may fret about the possible impact on national security of having foreigners own US infrastructure, the fact is that the infrastructure is located in the US and the government can always intervene, if and when national security is threatened.
In conclusion, there is little doubt that closer China-US economic cooperation is a positive-sum game – both countries can win.
The economic recoveries taking place in both countries should help to increase confidence on either side and the probability of an eventual agreement.
Chinese economic growth has now stabilised at an average annual rate of between 6 per cent and 7 per cent, two to three times higher than that of the US. Thus, in the foreseeable future, the rate of growth of Chinese demand for US exports of goods and services is likely to be much higher than that of US demand for Chinese goods and services, so the bilateral trade deficit should be further narrowed.
Any all-out trade war will be damaging for both. I believe rationality, and more importantly, self-interest, will prevail, and prevent a serious trade war from occurring.
Lawrence J. Lau is Ralph and Claire Landau Professor of Economics at the Chinese University of Hong Kong