Do you remember when China was accepted into the World Trade Organization in 2001? Presidents Clinton and Bush, as well as many other public policy leaders, predicted that it would improve the U.S.-China trade balance and would encourage China to abandon communism for free-market capitalism, both of which would benefit America.
I don’t know how they got it so wrong. After 15 years, we can say from experience that none of those predictions have come true.
The U.S. deficit with China has ballooned from $83 billion in 2000 to $366 billion in 2015. This is a total of $3.6 trillion in deficits with China. During this same period, the U.S. lost 5 million manufacturing jobs.
China is still a communist dictatorship, though it has adopted a few aspects of capitalism in order to participate in global trade. Unlike America’s free-trade approach, communist capitalism operates on the strategy of mercantilism and plays the game by its own rules.
The U.S. has been an enabler to China’s approach. China continually challenges the U.S. by ignoring free-market rules and doing whatever it takes to capture market share. Meanwhile, the U.S. looks the other way when China breaks the rules, thus encouraging them to do it again.
The most recent example is the steel industry. According to The American Steel and Iron Institute, American steel mills have had to layoff 13,500 employees because China has been dumping steel in the U.S. The Chinese steel companies can sell steel at below-market prices because they are state-owned and, by definition, are subsidized by the government. [The U.S. in May affirmed that China had been dumping cold-rolled steel; the International Trade Commission will make public its ruling on the case on June 30.]
Further, a recent lawsuit by United States Steel Corp. (IW500/91) charges China with price fixing, stealing the company’s trade secrets, and shipping steel to the U.S. through other countries so buyers won’t know the country of origin.
China is not a market economy, much less a free-market economy."
China is not a market economy, much less a free-market economy. Still, the U.S. continues to treat China as a free-market economy, with the hope that it will somehow encourage them to begin playing by the same rules governing the rest of the world. But, alas, it's not happening. Here is a short list of some of China's strategies.
- Currency Manipulation – China manipulates its currency to keep the U.S. dollar value high, so that Chinese companies have a 30% to 40% cost advantage. This undervaluation is illegal and should be considered to be a direct export subsidy, yet the Commerce Department has refused to treat currency undervaluation as actionable under the law.
- State-Owned Enterprises (SOE) – China owns and subsidizes many companies, as in the steel industry example, above. Through the subsidized companies, China can target a market with low-cost products, capture market share and drive competitors out of business.
- Technology Theft – China knows that technology and innovation is what can make them the No. 1 manufacturer in the world, and they are prepared to get it any way they can. They have been accused of using espionage, counterfeiting and buying American technology companies as standard strategies. According to the US-China Economic Panel Security Commission’s 2015 report to Congress, “China’s government conducts and sponsors a massive cyber espionage operation aimed at stealing trade secrets and intelligence from U.S. corporations and the government.” This includes blocking U.S. company websites, revoking business licenses and censoring the internet.
- Technology Transfer - As a condition of accessing the Chinese markets, China requires U.S. companies that build plants in China to create joint ventures with local companies—and share with them their latest technologies. Testimony to Congress by Patrick A. Mulloy asserts that we are slowly losing the Advanced Technology Products industries to China. Advanced technology products includes the more advanced elements of the computer and electronics industry as well as life sciences, biotechnology, aerospace and nuclear technology, all of which are central to U.S.'s own innovation strategy. In 2014, the U.S. trade deficit with China in advanced technology products was $123 billion.
- Research & Development Facilities - China requires foreign companies with plants in China set up R&D facilities in China. As a result, foreign companies have built more than 1,000 R&D labs in China.
The Results of China's Unfair Trade Practices & U.S.'s Weak Response
So what are the results of China's unfair trade practices?
First, by now, everyone knows that trade agreements do not benefit all citizens; there are winners and losers. The winners are the multinational corporations who have plants in China. The losers are American small businesses and workers. The initial promotion of China trade promised that consumers would be better off because of the cheap imported products. However, China trade created a $3.6 trillion deficit, which eliminated jobs and stagnated wages. It is part of the reason the rich have gotten richer and the poor poorer.
Second, the economic strength built upon these practices has helped China grow its military might. According to the U.S.-China Commission, China continues to modernize its forces
"... creating additional challenges for the United States and its allies. Most notably, China conducted its first test of a new hypersonic missile vehicle, which could enable China to conduct kinetic strikes anywhere in the world within minutes to hours, and performed its second flight test of a new road-mobile intercontinental missile that will be able to strike the entire continental United States and could carry up to 10 independently maneuverable warheads.
“China is making big investments in modern submarines, ships and combat aircraft. For the first time, its Navy began combat patrols in the Indian Ocean. Its first aircraft carrier has conducted a long-distance deployment. China is exerting force to control its claims in the East and South China Seas.
"Perhaps of most concern is Beijing's apparent willingness to provoke incidents at sea and in the air that could lead to a major conflict as China's maritime and air forces expand their operations beyond China's immediate periphery."
What's Up with the U.S. Response to China's Trade Practices
Every Congress and administration since President Clinton has ignored China’s illegal strategies. Instead of facing up to the problems, the U.S. has chosen dialog, diplomacy and collision avoidance over enforcement.
This policy is generally called forbearance, which is based on the illusion that China will eventually see its interests best fulfilled by following the rules. After 15 years since joining the WTO, these policies have failed. China is the winner; it is a rogue nation whose reaction to our diplomacy is to be ever more aggressive because we have not retaliated. The U.S. is like the mouse who has seen the circling hawk shadow. Its strategy is to stay very still in hopes the hawk won’t see it.
Why has America taken this approach?
The limited response to China's aggressive trade policy has many origins.
First, multinational corporations and Wall Street spend a lot of lobbying money on both the Congress and the administration to avoid confrontations and to maintain the status quo. In 2008, as a presidential candidate, Barak Obama said: “China’s current trade surplus is directly related to its manipulation of its currency value." But as soon as he was in office, his Administration's rhetoric changed.
In 2015, Treasury Secretary Timothy Geithner praised China’s announcement that it would move to a more flexible exchange rate. But, alas, the renminbi only increased 1%; we'd been duped again. Later, Obama's next Treasury Secretary, Jacob Lew, said doing anything about currency manipulation "would have the unintentional consequences of stopping global banks from buying bonds to combat weak growth."
Kurt Campbell, who was assistant secretary of state for Obama, argued for a policy of conciliation in order to avoid the trap of two great powers clashing (collision avoidance). Other staff members say that Obama worried that putting any pressure to stop China's cheating would put them on the defensive and may backfire. And of course every administration is worried that if we upset China, they may quit loaning us the money to finance deficits. The policy of forbearance has not worked, and it is ironic that the most ruthless and unlawful are winning over the most lawful and ethical.
Still another argument used by conservatives is that anything we do to stop China from cheating will be viewed by China as protectionism, which could lead to a trade war. I find this kind of thinking laughable. We are already in the trade war, and China is a decisive winner. Mao Zedong said, “Communism is not love. Communism is a hammer which we will use to crush the enemy.” When will we wake up to the fact that China is a rogue economic power that will always take advantage of weak nations thatwon’t confront cheaters?
It is time to confront China, and we should begin with currency manipulation. It seems that government’s biggest fear is that China will stop loaning us money to finance the trade deficit. But there is a precedent for taking action. In 1971, both Germany and Japan began manipulating their currencies. The Reagan administration imposed a 10% surcharge on their imports, and they immediately quit manipulating their currencies. We need to do the same thing to China and other Asian countries, but the surcharge should start at 25% and be reduced accordingly if they comply.
New York Times columnist Paul Krugman makes the case that this surcharge (tariff) with China is not as dangerous as people think. He says, “Clearly, nothing will happened until or unless the United States shows that it is willing to do what it normally does when another country subsidizes its imports: impose a temporary tariff that offsets the subsidy.” He goes on to say, “It is true that the dollar would fall if China decided to dump some American holdings. But this would actually help the U.S. economy, making our exports more competitive.” The tariff should be announced as proportional to the deficit and be reduced as the trade deficit is reduced.
Why Standing Up to China's Unfair Trade Practices Might Work
Our imports from China employ millions of Chinese workers, and any reduction in imports would force big layoffs. This is a big threat to the Chinese government.
The article Myths and Facts about China trade says, a surcharge “will not likely have a major effect on the cost of consumer goods; to the extent that wholesale prices do rise, past history suggests retailers would absorb some of the blow themselves by accepting a lower profit margin.”
This article also asks the following questions:
- Wouldn’t China selling off our debt destroy our economy and ability to borrow as a nation? China selling off its debt would hurt China’s economy even worse since they have invested so heavily in the U.S. China has $1.5 trillion in U.S. assets and there is simply no one that would buy them. China would be forced to take a huge loss on these assets. So it’s unlikely they would do anything that would negatively affect their own economy.
- What if China retaliates by refusing to buy our debt or selling off all of our debt? This is a good thing. As economist Dean Baker argues “The United States has absolutely nothing to fear from China’s decision to reduce its investments in the United States and allow the dollar to fall and the yuan to rise. This decision would mean that the United States could finally get its trade deficit down to a manageable level. The trade deficit has been the leading imbalance in the U.S. economy over the last decade.” Clearly, NOT doing anything would only make the problem worse.
- Won’t pushing China on currency make it more difficult to address our own budget deficit? The opposite is true. Producing more products in the United States would mean more Americans working and paying taxes instead of collecting unemployment, thus helping us to reduce our budget deficit. It would mean we are earning money instead of borrowing to buy things, leading to a more stable economy.
Krugman says, “In short, right now America has China over a barrel, not the other way around.” I think resistance to this plan would come from the multinational companies who have plants in China, more than the Chinese government.
The Congress and the administration need a plan.
- First they need to commit to the goal of reducing the trade deficit. This is a big deal because many companies and politicians don’t think trade deficits are a threat.
- Currency manipulation is illegal under Article IV of the WTO agreement, and it is time to make the formal complaint.
- Develop a list of technologies that we don’t want China to have for their military build-up, and make it illegal for companies to give them to China under any circumstances.
- Do not allow China to bid on any military or government contracts.
- The Senate just passed The Defend Trade Secrets Act to allow companies victimized by theft of trade secrets to sue in federal court. But on May 11 2016 Chinese state owned entities backed by their government said that they have a sovereign immunity and can’t be sued. The Trade Secret Act won’t do any good unless we can enforce it. China has again thumbed its nose at us.
Now, I know the free market capitalists will scream protectionism and criticize any effort to tax Chinese imports. But they do not offer any solutions to the growing list of Chinese problems listed in this article. The surcharge on Chinese imports is a temporary solution, and will be eliminated as soon as the Chinese quit manipulating its currency.
If we keep playing the game using a forbearance policy, and China continues to break the rules, in 10 years we will increase the Chinese deficit another $3.6 trillion, probably lose another 5 million jobs, and they will have most of our advanced technology products. In addition, we may have to face China’s military in the South China Sea. I think this problem is at least as threatening as the war on terror because China now has the power to kill our economy.
It is time to stand up.
Michael Collins is the author of Rising Inequality and the Decline of the Middle Class. He can be reached at mpcmgt.com