US China Relations

To Cut China Trade Gap, Invest in America

June 5, 2018
If the Trump administration really wants to address the deficit with China, start investing now.

One reason the U.S. and China can’t figure out how to negotiate on trade may be that the Americans are making two sets of demands that are antithetical to each other, without even realizing it.

On one side are threatened sanctions targeting the Made in China 2025 program of technology development and those against ZTE Corp. The headline tariffs, sometimes $50 billion, sometimes $150 billion, are aimed at the 2025 plan but more broadly attack a range of Chinese industrial practices, as described in an investigation by the Department of Commerce. The ZTE action focuses on that company’s sales of U.S. technology to Iran, but also is about a decades-long agenda created and funded by the Chinese government to acquire foreign technologies – an agenda in which ZTE and other state-owned technology companies have been willing partners.

The problem with the tariff threat and curbs on ZTE is that sanctions will increase, not decrease, the trade gap, and that’s the other side of the equation. U.S. technology companies sell a lot of semiconductors and other high-end components to China. China does not export much of its Made in China 2025 technologies; the issue is unfair transfer of U.S. technology.

This second grievance, the trade gap, is the more common Trump rallying cry. There’s really only one effective way to address that and cut the deficit: invest in America.

The first culprits in China’s growing trade surplus were multinational corporations. In the early days of its development, China built a set of geographic zones hermetically sealed from the rest of the mainland to get foreign direct investment in and products out. These zones invested in infrastructure and offered preferential tax rates to foreign companies. Corporations manufacturing for the export market were directed to these zones, partly because of their superior facilities but largely to insulate the general population from the corrupting influence of foreigners.

By 2004, the 4 million workers (out of almost 800 million employed across Chinese industry) in 54 special zones generated 5% of China’s GDP and $80 billion of exports – 41% of the total that year. Those exporters were preponderantly international companies.

Foreign companies moved their manufacturing operations away from their home countries and to these small, segregated parks on the coast with solid infrastructure, cheap labor, low taxes, and a degree of autonomy, including leeway for local officials to take commissions on income from direct investment.

This transformation would not have occurred without the IT revolution. By the late 1990s, internet and higher-quality computing technologies opened up the possibility of fracturing manufacturing value chains: Management in one location, fabrication in another, dozens of choreographed suppliers delivering to a remote assembly site in time to minimize inventory.

Companies became more specialized. The great churches of commerce like AT&T Inc., General Motors Co. and Caterpillar Inc. rapidly became less relevant, because the services they once provided – finance, human resources, engineering, R&D – could be furnished independently and marketed across large territories. The costs of bloated administrative centers around C-suites began to look unsustainable, and all the big companies understood that they needed to make savings to stay competitive.

Another, perhaps under-appreciated effect of information technologies was the regulatory arbitrage that they enabled. If company operations can be distributed, it makes sense to place revenue-generating activities in tax havens and to move corporate overhead, such as service centers, to lower-cost places like India and Ireland.

And Chinese companies, armed with new internet tools that gave them a window into foreign countries, could home in on small niches in the value chain – Louisiana crawfish? Georgia sandstone grave markers? Dolls that look like their owners? – replicate those products, and deliver them to markets 7,000 miles away at a 40% discount. It was capitalism at its most unrestrained.

There is nothing inherently wrong with trade deficits. But they’re related to the U.S. economic restructuring that occurred in response to globalization. The real problem with that restructuring is in the distribution of the economic benefits of trade. Instead of taxing corporations that were offshoring their operations and using the proceeds to invest in American education, health, and physical infrastructure, successive governments handed the gains from trade to increasingly concentrated corporations and their increasingly wealthy shareholders.

Ultimately, a trade deficit represents the excess of consumption over investment. If the Trump administration really wants to address the deficit with China, start investing now. Take a look at America’s crumbling infrastructure and compare it with China’s. That should tell you something.

By Anne Stevenson-Yang

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Licensed content from Bloomberg, copyright 2016.

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