Commentary

Pen Beats Sword

U.S. and Chinese government delegations reconvene in China today and tomorrow for the third installment of the semiannual “Strategic Economic Dialogue.” Among the issues on the agenda are product safety, financial-sector reform, investment policy, intellectual property rights, and currency reform.

Many of these topics have been front and center since the SED commenced last year, but SED III is unique for one very important reason: its relative quiet. Absent from the periphery this time are the political theatrics that colored the previous two installments. Congress isn’t menacingly threatening provocative actions if discernible progress isn’t made immediately. And that in itself is a welcome sign of progress. The bilateral relationship appears to be maturing.

The SED was created as a forum for discussing, understanding, and ultimately resolving structural problems affecting the bilateral relationship. It was not envisaged by its founders to be a venue for quick fixes. Yet that is how many members of Congress painted the two previous SEDs, partly to accentuate their get-tough-now legislation and partly to perpetuate perceptions that the Bush administration’s approach to China was failing.

The SED’s detractors argue that longstanding gripes remain unresolved: the Chinese yuan is still undervalued; the bilateral deficit continues to grow; opaque market barriers persist; intellectual property piracy continues; industries still receive government subsidies. All of those assertions have merit, but to a lesser degree with each successive SED. Progress has been made on all of these issues.

The wisdom of preferring dialogue to sanctions was affirmed by the announcement last week of a resolution to the Chinese subsidies dispute, a formal U.S. complaint lodged in the World Trade Organization earlier this year. The Chinese government agreed to terminate certain tax provisions that encouraged consumption of Chinese-made components and products at the expense of imports, and others tax rebates that subsidized Chinese exports. Had U.S. policy reflected the wishes of those in Congress who disparage the SED and who favor provocative, unilateral sanctions, quick resolution would have been highly unlikely.

Slowly but steadily, the currency issue is moving toward non-issue status.”

Since July 2005, when the Chinese currency was first pegged to a basket of currencies (no longer the dollar exclusively), the yuan has appreciated by 12 percent against the dollar. Its rate of appreciation has picked up in recent months and with inflation accelerating throughout China, the central bank is highly likely to allow further and faster appreciation henceforth. The yuan will soon have appreciated by 15 percent, which is the lower limit of the range of undervaluation estimated by economists. (Remember, the proposed Schumer-Graham tariff of 27.5 percent was the midpoint on the range of 15 to 40 percent).

The fact that, lately, U.S. legislators have been more circumspect and less public in their demands for currency appreciation is helping. If there is anything American policymakers have learned about their Chinese counterparts, it is that they do not respond well to external pressure. The Chinese recognize it is in their interest to allow the currency to appreciate; demanding it of them only makes it more difficult. Slowly but steadily, the currency issue is moving toward non-issue status.

Of course, most of the focus on currency reflects angst about the bilateral trade deficit, which is projected to be larger this year than last. It remains to be seen whether a more dramatic adjustment in the currency slows or reverses the growing deficit. So far, the 12 percent increase in the yuan’s value has been matched by a 68 percent increase in the bilateral deficit, which undermines the currency hawks in Congress and bolsters the argument of Treasury Secretary Henry Paulson: The trade imbalance has little to do with trade and currency policy; its cause is structural. The Chinese save too much and the Americans spend too much.

One of the reasons for excessive thrift in China is that the markets for hedging life’s uncertainties — health insurance, disability insurance, life insurance, and retirement accounts — are underdeveloped. One of Secretary Paulson’s objectives through the SED is to help the Chinese develop markets for these kinds of risk sharing products and services. Paulson has also been instrumental in convincing the Chinese to liberalize restrictions on credit cards, which will make consumption in China more convenient (and provide huge business opportunities for American financial institutions).

Complaints about less obvious market barriers and intellectual property rights violations in China continue, but the SED provides the best outlet for discussing, and often resolving those issues. In those instances where resolution is beyond reach, filing a formal WTO dispute is a legitimate option. Two of the five cases brought by the United States against China in the WTO were resolved quickly with China changing the offending policies. The other three may require formal adjudication. In either case, these are legitimate alternatives to unilateral sanction, and they each begin with dialogue.

Daniel Ikenson is associate director of the Center for Trade Policy Studies at the Cato Institute.