The China Business Forum recently (January 2006) released a report titled “The China Effect†that claims “the long-term benefits to the United States of Trade with China are substantial and likely to endure (Executive Summary).†The top line conclusion of the report is that the average US household stands to be one thousand dollars better off by 2010 as a result of lower prices and increased productivity in the U.S. due to the China effect. The bottom line take-away from reading the report is that it is flawed and misleading. Here is why.
The report seeks to dismiss the idea that China’s trade deficit has been growing more rapidly than the US deficit with other countries, and to this end it reports that China’s share of the overall deficit has remained fairly constant at around 20 percent for more than a decade. This is misleading. The proper measure of what has been happening is the ratio of the US-China trade deficit relative to the U.S. deficit with other countries. That tells us how trade with China has been evolving compared to trade with everyone else. That ratio has been growing fast. In 1994 the US-China deficit was 24.4 percent of the US deficit with the rest of the world. In 2004 it was 33.1 percent of the deficit with everyone else. And when they are released, the 2005 numbers will show that it has increased again since the China deficit grew by 25.8 percent through November 2005, while the deficit with the rest of the world (including OPEC) grew by only 15 percent.
A second claim is that Chinese imports have merely displaced imports from other East Asian economies: “…the deterioration in the trade deficit with China has come at the expense of other East Asian exporters to the United States (p8).†The reason given is that this displacement reflects a profound shift in production patterns by Asian and other multinational firms operating in the region. The logic of this claim is economically unsupportable. Businesses do not relocate to China because they like moo shu pork. They relocate because costs are lower, and those lower costs enable them to export more to the US. Absent those lower costs they would have exported less.
Moreover, the displacement hypothesis assumes that other East Asian economies have the economic slack to produce what China produces. This is ludicrous. Other East Asian economies are operating close to capacity, and there is no way they could step in and replace China’s exports. That means China’s exports are substantially an addition to the steadily rising stream of exports that other East Asian economies have still been able to produce.
The central claim of the report is that the ordinary American worker and household will be significantly better off as a result of trade with China. The claim is pushed using the artifact of the average household, which the report claims will receive “an increase of around $1,000 in real disposable income†per year by 2010 because of trade with China. But the average household is a statistical figment created by dividing total GDP by the total number of households. What really matters is what happens to real hourly wages and median household income – which is the income of a real world household situated in the middle of the income distribution. Here, the data for the last four years are clear. Real hourly wages have been essentially flat, and median household income actually fell from $46,058 in 2000 to $44,389 in 2004 – a decline of $1,669. The reason is that all productivity growth is going to profits, and none to wages. Chinese wage competition, China induced manufacturing job loss, and the persistent threat of off-shoring are part of the explanation.
Additionally, the report fails to address the question of sustainability. Right now the US is trading away manufacturing jobs and its manufacturing sector in return for cheap consumption goods. This trade involves racking up massive trade deficits, the proceeds of which China invests significantly in Treasury bonds. Interest on these bonds must be paid, which means that part of every tax dollar paid by Americans will in future be paid to the Chinese government. More importantly, there is the question of what happens if this arrangement breaks down. In that event, what will be the cost to the US economy and standard of living of a high dependence on imports combined with an atrophied manufacturing sector? The report provides no estimate of this scenario.
Lastly, there is no acknowledgement of the long-term national security issues that must be part of any assessment of the US – China economic relationship. These issues concern the implications of dependence on Chinese supplies, and transfer of high technology and manufacturing capacity to China, a country that may yet turn out to be a geo-political threat to the US. These issues are undoubtedly hard to cost, but that does not make them less real. By ignoring them, the report implicitly zero costs them. That is unrealistic.