Commentary

The Case for Economic Liberalism

This article appeared in the South China Morning Post on August 23, 2006.

China’s record trade surpluses with the United States are not pleasing to the U.S. Congress or to the many China hawks on Capitol Hill. With little movement in the yuan/dollar exchange rate since it was revalued by 2.1 percent in July 2005, pressure is mounting to bring the Schumer-Graham bill to the floor for a vote in the fall. Placing prohibitive tariffs on Chinese imports, however, will not correct the trade imbalance.

Rather than going down the path of destructive protectionism, the United States should get its own house in order by reducing the size and scope of government and by reaffirming its commitment to economic liberalism. Indeed, if the PRC is not to become the inevitable enemy that some on Capitol Hill envision, the United States must continue its policy of engagement.

Financial liberalization will take time, and China will move at her own pace. The United States should be patient and realistic. Most of the costs of China’s undervalued currency are borne by the Chinese people. Placing prohibitively high tariffs on Chinese goods until the yuan/dollar rate is allowed to appreciate substantially is not a realistic option. It would unjustly tax American consumers, not correct the overall U.S. current account deficit (or even our bilateral trade deficit with China), and slow liberalization.

Adjustment requires that China not only allow greater flexibility in the exchange rate but also allow the Chinese people to freely convert the yuan into whatever currencies or assets they choose. Capital freedom is an important human right and would help undermine the Chinese Communist Party’s monopoly on power by strengthening private property rights.

A more liberal international economic order is a more flexible one based on market-determined prices, sound money, and the rule of law. We should help China move in that direction—not by threats but by example. The U.S. government should begin by reducing its excessive spending and removing onerous taxes on saving and investment.

An orderly adjustment based on market-liberal principles would help ease the costs to the global economy and to the United States in particular. Keeping our markets open sends an important signal to the rest of the world, and getting our fiscal house in order—by trimming the size of government and by real tax reform—would show that we mean business. Reverting to protectionism, on the other hand, would have a negative impact on the global financial system, and adjustment would be slower and more costly.

For its part, China can help restore global balances by moving toward a more flexible exchange rate regime and liberalizing capital outflows so that there will be less pressure by the People’s Bank of China to accumulate foreign reserves, which now stand at more than $941 billion. Delaying adjustment means faster accumulation of reserves, greater risk of capital losses by holding dollar assets, and a stronger incentive to diversify.

The failure to address global imbalances means the failure to accept economic liberalism. China needs to move toward a market-liberal order, which means it needs a rule of law that protects persons and property. As Wu Jinglian, one of China’s leading reformers, recently stated: “If we don’t establish [a] fair rule of law and don’t have clear protection of property rights, then this market economy will become chaotic and corrupt and inefficient.”

Congress can best foster sound U.S.-China relations by not treating China as an inevitable enemy and by taking the opportunity to capitalize on China’s emergence as a market economy, albeit a “socialist market economy.” In particular, U.S. policymakers should

  • treat China as a normal rising power, not as a probable adversary;
  • continue to liberalize U.S.-China relations and hold China to its WTO commitments;
  • recognize that advancing economic freedom in China has had positive effects on civil society and personal freedom for the Chinese people.

Adherence to the principles of a liberal international order—as opposed to muddling that policy conception by threatening to adopt protectionist measures intended to force international agreements that may distort the international price system—should be the primary object of U.S. policy.

James A. Dorn is a China specialist at the Cato Institute and coeditor of China’s Future: Constructive Partner or Emerging Threat?This article is based on his recent testimony before the U.S.-China Economic and Security Review Commission.